Business Taxes

Business organizations are subject to taxation by federal, state, and local governments. This post discusses only general principles of taxation, for specific rules regarding income, deductions, etc. please talk to an accountant or tax attorney.

Federal Taxes

Income Tax

Regardless of whether you own a business or not, you will be subject to Federal Income Tax. You will report your income every year and pay any taxes you owe, just like you always have. Whether the income you receive from the business is compensation for your labor or a distribution of profits, it is still subject to federal income tax for you individually.

But, depending on how your business entity is categorized by federal tax law, your business may also have to report its income, or the income may be reported on your personal tax return and the taxes paid by you, or both you and the business may be responsible for reporting income and paying taxes separately.

Federal tax law categorizes businesses in one of three ways, generally:

1. disregarded entities,
2. pass-through entities, or
3. corporate entities.

Disregarded Entity

The disregarded entity pays no income tax and files no tax return. Federal tax law doesn’t recognize the business as an entity separate from the owner of the business. The owner of the disregarded entity reports all income from the business on the owner’s federal income tax return and pays all income tax on income from the business. Sole proprietorships and one-owner LLCs are disregarded entities.

Pass-through Entity

A pass-through entity pays no income tax but must file a return. The income tax is assessed at the owners’ level. The return includes the amount of income that is distributive to the partners. The business provides each owner with a Schedule K-1 that lists the owner’s share of the profits or losses. The owner reports that amount of profit or loss on the owner’s tax return. Partnerships, multiple-owner LLCs, and S-Corporations are pass-through entities.

Corporate Entity

A corporate entity pays income tax and files a return. A corporation’s income is taxed at graduated rates that range from 15% to 35%. When the owner of a corporation receives a dividend from the corporation, that dividend counts as income for the owner. Therefore, the dividend must be reported on the owner’s income tax return and the owner must pay any income tax associated with that income. This is referred to as double taxation, because the income from the business is taxed twice; once at the corporate level and a second time at the owner level. Corporations and LLCs that elect to be taxed as corporations are corporate entities for federal tax purposes.

Employment Tax

Regardless of how your business entity is categorized, federal tax law requires payment of 15.3% of wages for social security and medicaid. When your business employs other people and pays them wages, your business is responsible for half of the social security and medicaid taxes, and the employee is responsible for the other half.

But, when you own the business and work for the business, the amount of social security and medicaid tax you pay depends on:

1. The classification of the business’s entity, and
2.  The amount of wages that would be reasonable compensation for your occupation in the business.

For sole proprietorships, partnerships, and LLCs,  you are responsible for paying 15.3% on all income you receive from the business. This is the self-employment tax.

For corporate entities and S-corportions, as an employee of the corporation you are responsible for paying 7.65% of the wages that are reasonable compensation for your occupation in the business. The corporation pays the other 7.65% of your wages. Any dividend you receive from the corporation as a distribution of profits is not subject to social security or medicaid, but it is still subject to income tax.

State Taxes

The State of Texas has no income tax. It does however, have a franchise tax and a sales and use tax.

Franchise Tax

The franchise tax applies to all business except sole proprietorships, general partnerships owned by natural persons, and other business that meet certain exceptions. In essences, that means corporations, LLCs, and LLPs are subject to the franchise tax.

A business doesn’t have to pay any franchise tax if it’s revenue is below $1,080,000. Although, it still must file a “No Tax Due Information Report.”

Businesses with revenue exceeding that amount must calculate their franchise tax amount by first determining their tax base and multiply their tax base by the applicable tax rate.

The tax base is determined by the lowest of:

1. total revenue minus cost of goods sold;
2. total revenue minus compensation; or
3. total revenue times 70 percent.

The applicable tax rate is:

1. 1.0% (.01) for most entities
2. 0.5% (.005) for qualifying wholesalers and retailers*
3. 0.575% for those entities with $10 million or less in Total Revenue (annualized per 12 month period on which the report is based) electing the E-Z Computation

Sales/Use Tax

Texas imposes a state sales tax on all retail sales, leases and rentals of most goods, as well as taxable services. Texas cities, counties, transit authorities and special purpose districts have the option of imposing an additional local sales tax for a combined state and local tax rate of up to 8 1/4% (.0825).