Understanding US Taxation for Business Owners: LLCs and Corporations 

Navigating the complexities of US taxation can be a daunting task for business owners, both for US residents and non-US residents.  Understanding the various aspects of taxation is crucial for making informed decisions and ensuring compliance with tax laws.  This blog post aims to provide a comprehensive overview of the key tax considerations for business owners operating LLCs and corporations in the United States. 

What are the Tax Considerations for Business Owners operating a Business in the USA? 

TAX CONSIDERATIONS FOR LLC 

  • Pass-Through Taxation: Limited Liability Companies (LLCs) are typically subject to pass-through taxation, meaning the business itself is not taxed directly. Instead, profits and losses are passed through to the individual members, who report them on their personal tax returns. For example, if an LLC has two members, A and B, who each own 50% of the business, and the LLC earns $100,000 in profits in a year, then A and B will each report $50,000 of income on their personal tax returns and pay taxes accordingly. 
  • Self-Employment Taxes: Members of an LLC may be subject to self-employment taxes on their share of the profits. This includes contributions to Social Security and Medicare. For example, if A and B from the previous example are both self-employed, they will have to pay 15.3% of their income ($50,000 x 15.3% = $7,650) as self-employment taxes. 
  • State-Level Taxes: Depending on the state where the LLC operates, there may be additional state-level taxes to consider, such as franchise taxes or annual report fees. For example, in California, an LLC must pay an annual franchise tax of $800, regardless of its income level. In addition, an LLC may have to pay an extra fee based on its total income from all sources. 

TAX CONSIDERATIONS FOR CORPORATIONS 

  • Corporate Income Tax: Corporations are subject to corporate income tax at the federal level. This is a separate tax from personal income tax and is based on the corporation’s profits. For example, if a corporation earns $100,000 in profits in a year, it will have to pay 21% of its income ($100,000 x 21% = $21,000) as corporate income tax. 
  • Double Taxation: C corporations face double taxation, where profits are taxed at both the corporate level and again at the individual level when dividends are distributed to shareholders. Double taxation means that the same income is taxed twice by different entities, resulting in a higher effective tax rate. For example, if a C corporation distributes $50,000 of its after-tax profits ($100,000 – $21,000 = $79,000) as dividends to its shareholders, who are in the 22% tax bracket, they will have to pay 22% of their dividend income ($50,000 x 22% = $11,000) as personal income tax.  Thus, the total tax paid on the $100,000 of profits is $32,000 ($21,000 + $11,000), resulting in an effective tax rate of 32%. 
  • S-Corporation Election: Some corporations may qualify for S corporation status, which allows them to avoid double taxation by passing corporate income, losses, deductions, and credits through to their shareholders. For example, if a corporation elects to be an S corporation and earns $100,000 in profits in a year, it will not pay any corporate income tax. Instead, it will pass through its profits to its shareholders, who will report them on their personal tax returns and pay taxes accordingly. 

INTERNATIONAL CONSIDERATIONS FOR NON-US RESIDENTS 

Non-US resident business owners must be aware of additional tax implications, such as withholding taxes on US-sourced income and potential tax treaties between their home country and the United States. For example, if a non-US resident owns a C corporation that operates in the United States and earns $100,000 in profits in a year, it will have to pay 21% of its income ($100,000 x 21% = $21,000) as corporate income tax. If it distributes $50,000 of its after-tax profits ($100,000 – $21,000 = $79,000) as dividends to its non-US resident owner, it will also have to withhold 30% of the dividend amount ($50,000 x 30% = $15,000) as withholding tax.  

Thus, the total tax paid on the $100,000 of profits is $36,000 ($21,000 + $15,000), resulting in an effective tax rate of 36%. However, if there is a tax treaty between the non-US resident’s home country and the United States, the withholding tax rate may be reduced or eliminated.  For example, if the non-US resident is from India, which has a tax treaty with the United States, the withholding tax rate on dividends is reduced to 15%. Thus, the total tax paid on the $100,000 of profits is $30,500 ($21,000 + $7,500), resulting in an effective tax rate of 30.5%. 

Which different taxes apply to businesses in the USA? 

Businesses in the USA are subject to various types of taxes at the federal, state, and local levels.  Some of the major taxes that businesses have to pay are: 

  • Income tax: This is a tax on the net income of a business entity, such as a corporation, partnership, sole proprietorship, or limited liability company. The federal income tax rate for corporations is 21% since 2018.  Partnerships and other pass-through entities do not pay income tax at the entity level, but their owners report and pay tax on their share of the business income on their individual tax returns.  The federal income tax rates for individuals range from 10% to 37%, depending on their taxable income and filing status. Some states and localities also impose income taxes on businesses and individuals, with varying rates and rules. 
  • Estimated tax: This is a method of paying income tax and self-employment tax (see below) in advance, based on the estimated income and deductions of the taxpayer for the year.  Businesses and individuals who expect to owe at least $1,000 in federal income tax for the year (after subtracting withholding and credits) must make quarterly estimated tax payments to avoid penalties.  Some states and localities also require estimated tax payments for their income taxes. 
  • Self-employment tax: This is a tax on the net earnings from self-employment of individuals who work for themselves, such as sole proprietors, partners, independent contractors, and members of limited liability companies.  The self-employment tax consists of two parts: Social Security tax (12.4%) and Medicare tax (2.9%). The Social Security tax applies to the first $142,800 of net earnings in 2021, while the Medicare tax applies to all net earnings. There is an additional 0.9% Medicare surtax for high-income taxpayers. Self-employment tax is reported and paid along with income tax, either through withholding, estimated tax payments, or annual tax returns. 
  • Employment Tax: This is a tax that employers have to pay and withhold from their employees’ wages. The employment tax consists of three parts: Social Security tax (6.2% for both employer and employee), Medicare tax (1.45% for both employer and employee), and federal unemployment tax (FUTA) (6% for employer only).  The Social Security and Medicare taxes apply to the first $142,800 of wages in 2021, while the FUTA tax applies to the first $7,000 of wages per employee per year.  There is an additional 0.9% Medicare surtax for high-income employees. Employers have to deposit the employment taxes with the IRS on a monthly or semiweekly basis, depending on their payroll size, and file quarterly or annual returns to report the taxes. Some states also impose unemployment taxes on employers, with varying rates and rules. 
  • Excise tax: This is a tax on the manufacture, sale, or use of certain products or services, such as gasoline, tobacco, alcohol, air transportation, indoor tanning services and health insurance providers.  The excise tax rates and rules vary depending on the type of product or service. Some excise taxes are paid by the producer or seller, while others are passed on to the consumer. Excise taxes are reported and paid to the IRS on a quarterly or annual basis, using specific forms. Some states and localities also impose excise taxes on certain products or services. Above are some of the main types of taxes that businesses in the USA have to deal with.  

However, there may be other taxes that apply depending on the nature, location, and size of the business.  For example, some businesses may have to pay sales tax, property tax, franchise tax, or alternative minimum tax.  Therefore, businesses should consult with a professional tax advisor to understand their tax obligations and plan accordingly. 

Disclaimer: The information provided on this blog is for general education and informational purposes only. It is not intended to be a substitute for legal advice.  The author of this blog is not a lawyer, and the content of this blog should not be relied upon as legal advice.  If you have any specific legal questions or concerns, you should consult with a competent professional.

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