Source: The Tax Foundation.
FIGURE 1-1: State marginal tax rates.
THE ALTERNATIVE MINIMUM TAX
In 1969, Congress created a second tax system — called the alternative minimum tax (AMT) to ensure that higher-income earners with relatively high amounts of itemized deductions pay at least a minimum amount of taxes on their incomes. When it was added to the federal income tax code in 1969, the AMT affected a mere 155 high-income taxpayers; in 2017 before tax reform was passed, it hit about 5 million taxpayers! Thanks to the Tax Cuts and Jobs Act, which took effect in 2018, AMT only impacts “just” 150,000 taxpayers annually.
If you have a bunch of deductions from state income taxes, real estate taxes, certain types of mortgage interest, large miscellaneous itemized expenses, or passive investments (such as limited partnerships or rental real estate), you may fall prey to the AMT. The AMT is a classic case of the increasing complexity of the U.S. tax code. As incentives were placed in the tax code, people took advantage of them. Then the government said, “Whoa! We can’t have people taking that many write-offs.” Rather than doing the sensible thing and limiting some of those deductions, Congress created the AMT instead.
The AMT restricts you from claiming certain deductions and requires you to increase your taxable income. So you must figure the tax you owe both under and out of the AMT system, and then pay whichever amount is higher. Unfortunately, the only way to know for certain whether you’re ensnared by this second tax system is by completing — you guessed it — another tax form. Form 6251, “Alternative Minimum Tax — Individuals” is a bear of a form, so if you’re confronting it for the first time, you may want to enlist the support of a qualified tax advisor. Also, be aware that if you don’t calculate the AMT on your return and you should have, the IRS will calculate the bill for the additional tax, interest, and possibly late payment penalties.
Corporate income tax rates
As I explain earlier in this chapter, the vast majority of small business owners pay income taxes on their business earnings at the personal income tax rates. That’s because most small businesses are organized as sole proprietorships, which have income taxed as personal income. Also, many other small businesses that are organized as partnerships, LLCs, and S corporations pass through their income to the business owners in such a way that it, too, is taxed as personal income.
Thus, only a small percentage of small business owners have their income taxed as regular, so-called C-corporations. The Tax Cuts and Jobs Act, which took effect in 2018, compressed the previous numerous corporate income tax brackets to just one rate — 21 percent. In the next chapter, I discuss how the tax rate a business pays along with other factors play a role in determining what the best business entity is for your business.
Employment (payroll) taxes
Business owners are responsible for the timely payment of all employee-related payroll or employment taxes. Some of these are withheld from the employees’ pay while others are paid by the employer. Here are the taxes I’m talking about:
Federal income tax withholding
State income tax withholding
Social Security and Medicare taxes (also known as FICA) — half paid by employer, half paid by employees
Federal unemployment tax — paid by employers
State unemployment tax
It’s imperative that you understand and properly withhold and pay all of these taxes on a timely basis. For a list of state tax authorities, visit www.taxadmin.org/state-tax-agencies. Otherwise, you and your business could be subject to stiff penalties and interest charges. Here’s an overview of the frequency with which employment taxes are required:
Larger employers (those who paid more than $50,000 in employment taxes the previous calendar quarter) must submit/deposit their employment taxes every two weeks.
Moderate-sized employers (those who have between $2,500 and $50,000 in employment taxes) can submit their employment taxes monthly.
Smaller employers (those who have less than $2,500 in employment taxes quarterly) may submit their employment taxes with their quarterly employer tax returns. Those with $1,000 or less for income tax withholding and Social Security and Medicare tax payments or federal unemployment tax payments under $500 can pay annually.
Employers must generally deposit these taxes electronically using the Electronic Federal Tax Payment System (EFTPS), which was originally launched in 1996 and doesn’t charge users. This system enables the transfer of your funds from your bank account to the U.S. Treasury.
If your annual employment taxes for your business exceed $1,000, you must file IRS Form 941, “Employer’s Quarterly Federal Tax Return,” each quarter. You can instead file IRS Form 944, “Employer’s Annual Federal Income Tax Return” if your annual employment taxes are less than or equal to $1,000.
To ensure the timely credit of your taxes, plan on submitting them at least one day before they’re actually due. Alternatively, your tax advisor, payroll service, bank, or other financial institution can make the deposit on your behalf.
For more information, visit www.eftps.gov or call 800-555-4477.
Also, remember that self-employed individuals need to pay self-employment taxes, which are Social Security and Medicare taxes. See Chapter 10 for all the details.
Sales taxes
As you probably already know from your years as a consumer, many towns, cities, counties, and states levy sales taxes on the purchase of particular goods and services. A related tax, known as a use tax, may be levied on the buyer of certain products from out of state.
As the seller of goods or services within a state with a sales tax, your business is obligated to collect and submit said tax to the relevant agency for sales tax collection in your state.
The Streamlined Sales Tax Governing Board was created by the National Governor’s Association (NGA) and the National Conference of State Legislatures (NCSL) in 1999 to simplify sales tax collection. By visiting their website at www.streamlinedsalestax.org/ you can find a list of Certified Service Providers that can help you collect and remit sales tax to the state(s) in which you do business. There is no cost to your business for this service, and using it eliminates any risk of your business being audited for sales tax collections.
Chapter 2