The U.S. Tax System: How Are Different Businesses Taxed?

The U.S. Tax System: How Are Different Businesses Taxed?

The tax system in the United States taxes businesses on their annual operating income or profit. The system makes sense because they’re probably paying taxes when a company makes money. However, the way the tax code is drafted makes the difference between a profitable business and an unprofitable one far more extreme than it needs to be. A good shoe store that turns a profit of $10,000 may owe no taxes, while a shoe store that loses money every year may be taxed at as much as 120 percent. Let’s look at some of the specific ways different businesses get taxed.

Income tax

A company’s income tax is based on its annual profit. Profitable businesses pay no taxes (or very little), while unprofitable businesses are taxed at rates as high as 120 percent of the net profits.

Self-Employment Tax (Employer of Last Resort)

While self-employment tax is not technically a business tax, it is levied on unincorporated self-employed individuals as if they were an employer of last resort. The IRS collects this tax by requiring the person to pay part of their income to themselves. Self-employment taxes are comprised of Social Security and Medicare taxes that you spend on your net income. You calculate these taxes by multiplying your net self-employment income by 0.9235 and subtracting the amount you contribute to a retirement plan, like a SEP or an IRA. If you do not have any retirement contribution, the rate is 12.4 percent (10.4 percent for Social Security + 2.9 percent for Medicare). Above specific caps, you will be exempt from paying self-employment tax altogether (unless other factors make you liable).

Payroll Tax

Payroll taxes refer to the taxes that an employer pays on their employees. These taxes are paid by employers at a rate of 6.2% and come from the employee’s paycheck. The two types of payroll taxes are Social Security and Medicare. – Social Security: This is a tax on wages for people who earn up to $117,000 per year (as of 2018). Employees should expect to contribute 6.2% in the payroll tax, with employers paying the other 6.2%. – Medicare: This is a tax on all employment income, including wages and self-employment income up to certain limits ($200,000 as of 2018). Employees pay 2.9% while employers pay 1.45%.

Capital Gains Tax

A capital gains tax is a percentage of the profit made on an investment. This is usually calculated based on the total asset value minus the original purchase price. If someone invested $1,000 in stock and sold it for $10,000, they would owe 20% capital gains tax. If the same person invested $1,000 in real estate and sold it for $10,000, they would owe 40% capital gains tax. Capital gains taxes are only due when you sell or transfer your asset to someone else. There are exceptions to this rule, like when you make a gift or inheritance.

Excise Tax

Certain types of businesses are subject to excise taxes, which are taxes on specific goods or products. These can be imposed at the manufacture or sale, and they can also apply to importation. An example of an excise tax is a gasoline tax.

Inheritance Tax

The U.S. federal government does not have an inheritance tax system. All individual states have a different inheritance tax system, which isn’t very easy to keep track of. Many people think that the federal government doesn’t have inheritance taxes because it would be too difficult to track them for everyone in the country, but many other factors are at play. As a result, the only way an individual could owe inheritance taxes to the federal government is if they inherit money from a deceased parent who owed income taxes at the time of death. In such cases, they would owe income tax on the amount they inherited from their parent plus any accumulated interest accrued when they died and received the inheritance.

limited liability companies

Limited liability companies are a type of company that, as the name suggests, is held liable for its actions. If they make a profit, they pay taxes on those profits. If they lose money, they don’t owe anything. If you’re starting a business and your goal is growth and yield, then apply for LLC. You will be taxed on your annual operating income or profit with this type of company.

Conclusion

The United States has a progressive income tax system with six levels of federal income tax, from 10% to 39.6%. State income taxes vary, but most states have a single-rate system. Some high-income earners in states with high state income tax rates may owe some federal income tax; this is called the Alternative Minimum Tax. Some employers and employees may also owe railroad unemployment insurance taxes, a flat rate of 6.2% of the first $7,000 in wages each year.

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