Key Takeaways

• Small business income tax directly reduces startup profit margins and requires careful cash flow planning.

• The chosen business structure sets the ultimate tax rate that founders pay.

• Federal, state, and local levies combine to create wide swings in effective tax rates across the country.

• Unmanaged payroll, self-employment, FICA, sales, and excise taxes erode net earnings fast.

• Deductions, credits, and timely estimated payments lower overall tax liability and free capital for growth.

• Rho's expense-tracking and tax-planning tools simplify compliance and protect cash for scaling.

How small business tax rates affect your startup’s bottom line

Your small business tax rate plays a crucial role in shaping your startup's success—but it doesn’t have to slow you down. Every tax decision you make, from choosing a business entity to managing expenses, directly affects your bottom line.

In this guide, we'll simplify how taxes impact your startup, whether you're running an LLC, sole proprietorship, or corporation. You'll get clear insights into federal, state, and local taxes, plus payroll, self-employment, sales, and excise taxes. We’ll also share practical strategies to minimize your tax burden and keep more capital for growth. Let’s dive in.

What does your small business tax rate include?

Your small business tax rate isn’t just one number, but a stack of taxes that apply at different levels. In most cases, your total rate includes:

1. Federal income tax – either at the corporate level (for C corps) or personal level (for pass-through entities).

2. State and local income or business taxes, which vary widely by jurisdiction.

3. Self-employment or payroll taxes – covering Social Security and Medicare.

4. Other taxes like excise taxes, sales taxes, and additional surcharges based on your industry or location.

These layers combine to form your effective tax rate, which can significantly impact your take-home earnings and cash flow.

1. Federal income tax

As mentioned, the federal income tax you pay depends on your business structure. 

C corporations pay a flat 21% corporate income tax directly to the IRS. Any dividends distributed to shareholders are then taxed again at the individual level, creating a second layer of tax.

Pass-through entities—like LLCs, partnerships, S corporations, and sole proprietorships—don’t pay federal income tax at the business level. Instead, profits flow through to the owner’s personal tax return, where they’re taxed using the 2025 individual income brackets, which range from 10% to 37%.

This federal layer forms the base of your overall tax rate before state, local, and payroll taxes are added.

2. State and local taxes

States and cities layer their own rules on top of the federal tax system. Some follow federal income brackets, others impose their own corporate rates, and a few levy taxes on gross receipts instead of profit. 

These taxes usually apply to your net income after deductions like the standard deduction, home office expenses, or qualified business costs.

On top of these, many business owners must also pay self-employment tax, which covers Social Security and Medicare contributions.

3. Self‑employment tax

If you actively work in your business, you’ll likely owe self-employment tax. This combines the employer and employee shares of FICA and Medicare, covering Social Security benefits. 

Sole proprietors and active partners pay this tax on their net earnings, unless the business uses payroll withholding or elects S corporation status and treats part of the profit as salary.

Once self-employment tax is added, it becomes important to understand how each dollar is taxed—whether at your marginal rate or across your total income.

4. Marginal versus average rates

Your marginal tax rate is what you pay on the next dollar of income. Your average effective rate, by contrast, shows the total percentage of your income paid in taxes.

Because income is taxed in brackets, how you receive it—whether as salary, dividends, capital gains, or retained earnings—can significantly affect your total tax liability.

Understanding the difference between these rates helps you manage cash flow, estimate taxes accurately, and choose the right business structure with confidence.

Next, let’s compare the consistency of federal tax rules with the complexity of state and local business taxes.

US federal income tax versus state-level business tax differences

Federal income tax provides a consistent foundation for all U.S. businesses—but what happens after that depends entirely on where you operate. State and local tax rules vary dramatically, and those differences can significantly change your startup’s total tax bill.

Here’s how federal rules stack up against the complex—and sometimes unpredictable—world of state and local business taxes.

As the table shows, while the federal income tax system provides consistency across all 50 states, state-level rules vary widely, creating distinct challenges for startups. 

Generally, states fall into three broad categories:

• No income tax: States like Texas, Florida, and Wyoming don't impose individual income taxes but generate revenue from alternative sources like franchise, sales, or gross receipts taxes.

• High-tax states: States such as California and New York impose significant personal or corporate income taxes, often layering additional surcharges on top of federal taxes.

• Low-tax states with indirect fees: Some states maintain lower income tax rates but compensate with higher fees, excise taxes, or other indirect levies.

Pass-through entities must track these state-level requirements carefully, as the tax implications affect both the business and business owners personally. 

Additionally, federal brackets adjust annually for inflation each January, but state-level bracket updates vary in timing and frequency. These differences can significantly impact your startup’s estimated tax planning and cash-flow management.

How your business structure affects your tax rate

Your business entity sets the rules for federal income tax, state business tax, payroll taxes, and even double taxation. By seeing how each structure treats gross income, deductions, and distributions, small business owners match cash flow to estimated tax payments, keep the IRS satisfied, and reduce overall tax liability. 

The sections below outline what happens to taxable income under every common form.

C corporation

A C corporation pays a flat federal corporate income tax rate of 21%. When it distributes dividends, shareholders report those payments on their personal income tax return, facing qualified dividend tax rates of 0%, 15%, or 20%, depending on their taxable income. 

That double taxation can still make sense when the business reinvests earnings or raises outside capital.

Sole proprietorship

A sole proprietor reports income on Schedule C; net earnings flow through personal tax brackets and incur a 15.3% self-employment tax (12.4% Social Security up to the 2025 wage base limit, and 2.9% Medicare). An additional Medicare surtax of 0.9% applies on earnings above $200,000 for single filers or $250,000 for married filing jointly.

 The owner pays both employer and employee shares, so timely quarterly estimated payments prevent penalties.

Partnership

A partnership functions as a pass‑through entity. Each partner receives a Schedule K‑1 that reports the share of business income. Active partners pay self‑employment tax on that slice, while limited partners escape the payroll portion on passive income. Nexus tests still pull the firm into state tax filings in every market where it sells.

Limited liability company

A limited liability company defaults to partnership treatment, sending profit to members’ personal returns. Owners may elect C corp status to lock in the flat corporate tax rate, retain earnings, or pursue an eventual stock sale. The choice shifts income from personal brackets to the corporate system and changes payroll‑tax exposure.

We dig into this in our guide on the tax advantages of LLCs, showing how default pass-through treatment and an S-corp election let owners split salary and distributions to reduce self-employment tax while staying compliant with reasonable compensation rules.

S corporation

S corporation owners pay themselves a reasonable salary subject to payroll taxes. Remaining profits are distributed without self-employment tax, lowering overall liability. This structure requires compliance with IRS reasonable compensation rules.

Now that you understand how each entity treats income, salaries, distributions, and payroll taxes, the next step is to turn those rules into a real tax bill. 

How to calculate a small‑business tax bill step by step

Every small business owner follows the same roadmap to see how much cash goes from the company to the IRS each tax year. These seven checkpoints use present‑tense actions and weave in the rules that govern every type of business entity.

1. Identify the business structure

Confirm whether you operate as a sole proprietorship, partnership, limited liability company, S corporation, or C corporation. Each choice unlocks a different tax regime, set of income tax rates, and potential double taxation.

2. Find taxable income

Start with gross income. Subtract ordinary and necessary business expenses, the standard deduction if allowed, and specific tax deductions such as a home office. The remainder equals taxable income or net income.

3. Apply federal brackets

C corporations multiply taxable income by the 21% corporate tax rate. Pass‑through entities map each slice of business income to the 2025 personal income tax brackets that range from 10-37% on the individual income tax return.

4. Add self‑employment tax

Active owners and independent contractors add the 15.3% self‑employment tax, which covers FICA and Medicare taxes for Social Security. Half of this amount stays deductible, and the 0.9% Medicare surtax applies above threshold income levels.

5. Layer state and local taxes

Next, apply state tax and local tax. Some states levy a corporate income tax, others charge a business tax on gross receipts, and most collect sales taxes or franchise fees. Nexus rules determine whether multistate taxpayers must file.

To see current nexus tests and when registration is required, consult the Sales Tax Institute's economic nexus state guide.

6. Include payroll and excise taxes

Add payroll taxes withheld for employees, plus any excise taxes on fuel, alcohol, or other regulated goods. Independent contractors handle their own estimated tax payments to stay current.

7. Check the total tax liability

A sole proprietor with $100,000 of net earnings pays federal income tax per the brackets and about $15,300 in self-employment tax before deductions. State levies push the total higher, so accurate estimated payments and proper filing status keep cash flow steady and compliant with tax laws.

That layered total becomes your tax liability, so small business owners can budget, make estimated tax payments, and adjust cash flow before year-end.

Ways to reduce your small business tax rate

Small business owners can cut their tax burden by doing four things together so the IRS sees less taxable income, and the cash stays in the business.

Track and document every expense

Start with gross income and subtract ordinary and necessary costs like equipment, advertising, software, mileage, and a home office. Keep receipts and business purpose notes in real time so net earnings fall and federal income tax, state tax, and local tax shrink.

Use the qualified business income deduction

Owners of pass‑through entities (LLCs, partnerships, sole proprietorships, or S corporations) can deduct up to 20% of qualified business income (QBI).

In 2025, you qualify for the full deduction if your taxable income is at or below $197,300 for single filers or $394,600 for married filing jointly. These thresholds are indexed for inflation each year. 

If your taxable income exceeds these limits, the deduction phases out and becomes subject to wage‑ and property‑based limitations. Specifically, your deduction is capped at the greater of:

• 50% of your share of W‑2 wages paid by the business, or

• 25% of your share of those wages plus 2.5% of the unadjusted basis of qualified property.

Choose the right business entity

Elect S corporation treatment to split profit into salary and distribution, paying payroll taxes for Social Security and Medicare while avoiding self-employment tax on the rest. Growing firms sometimes shift to C corporation status to lock in the flat corporate tax rate and delay personal tax on dividends, weighing double taxation against retained earnings and capital gains planning.

​​We walk through when an S corporation election makes sense in our LLC tax advantages article, including how to set a reasonable salary and structure distributions to lower overall tax liability without running afoul of IRS rules.

Time income and keeping books clean

Strategically timing income and maintaining clean bookkeeping records can significantly lower your tax bill. 

Use Section 179 immediate expensing (allowing write-offs of up to $1,220,000 in asset purchases, adjusted annually) and bonus depreciation (deducting 60% of qualified asset costs for 2025, phasing down annually until expiration in 2027) to accelerate asset deductions (IRS Publication 946). 

Additionally, make retirement contributions to shift taxable income into lower brackets. Real-time bookkeeping ensures accurate tracking of gross receipts for sales and excise taxes, and helps schedule timely estimated tax payments. Accurate, timely records also protect your filing status and help minimize overall tax liability.

Other tax obligations to plan for

Income tax captures attention first, yet several companion taxes shape the real cash picture for every small business owner. Understanding each layer keeps estimated tax payments accurate, prevents penalties, and supports steady cash flow throughout the tax year.

Payroll taxes

Every paycheck carries federal income tax withholding, plus payroll taxes. Payroll taxes include employer and employee contributions, each typically covering half of the total FICA (Social Security and Medicare) taxes. 

The IRS requires monthly or semiweekly deposits. That’s why reliable payroll software—that tracks gross pay, net pay, withholding amounts, and filing status for each worker—can help ensure timely deposits. Accurate records protect you from late-payment penalties and keep your business compliant.

Self-employment tax

Sole proprietorships, active partners in partnerships, and members of limited liability companies pay self-employment tax at 15.3% of net earnings. Half of that amount stays deductible on the individual income tax return. Quarterly payments that match real‑time profit prevent year‑end surprises and keep tax liability predictable.

Additional Medicare tax

When wages or self-employment income exceed $200,000 for single filers, $250,000 for married filing jointly, or $125,000 for married filing separately, the additional Medicare surtax of 0.9% applies. Owners monitor both salary and pass-through profit to avoid triggering it unexpectedly.

Excise taxes

Businesses dealing in regulated goods such as fuel, alcohol, or firearms must file periodic excise tax returns. Rates and filing schedules vary by product, so detailed inventory tracking helps ensure compliance.

Sales and gross receipts taxes

States and many cities impose sales taxes on retail transactions and gross receipts taxes on total revenue. In 2018, the Supreme Court’s Wayfair decision allowed states to enforce economic nexus laws—meaning that even if a business has no physical presence in a state, it must collect and remit sales tax once it crosses certain thresholds in sales volume or transaction count.

For startups selling online, especially across state lines, this adds significant complexity. E-commerce platforms that automatically calculate and collect sales tax at checkout help ensure compliance across multiple jurisdictions.

Property and local levies

Counties assess property tax on real estate and, in some areas, on business equipment. Municipalities may layer privilege or headcount taxes on top. Reviewing assessment notices early lets owners appeal inflated valuations and budget cash before payment deadlines arrive.

Planning for payroll taxes, self-employment tax, Medicare surtax, excise taxes, sales taxes, and local levies alongside federal and state income tax gives small business owners a full view of the tax burden, aligns cash forecasts with reality, and upholds compliance with evolving tax laws.

E-commerce and international tax rules for pass-through entities

After Wayfair, remote sales trigger economic nexus when activity exceeds state-specific sales or transaction thresholds, so pass-through entities such as LLCs, S corporations, partnerships, and sole proprietorships monitor gross receipts and customer locations. 

When a threshold is crossed, the business registers, collects, and remits the required sales tax, and files the state return. Owners update the nexus status regularly because the tests differ by state and change over time.

The United States taxes worldwide income, so foreign-source earnings from pass-through operations appear on the individual income tax return. 

Owners use tax treaties and the foreign tax credit to avoid double taxation by offsetting qualifying foreign income taxes against US federal income tax, with limits based on the ratio of foreign to worldwide income. Value-added taxes do not qualify for the credit and are handled separately. 

Accurate accounting that separates income by country, records foreign withholding, and maintains proper filing status keeps small business owners compliant while protecting cash flow.

See IRS guidance on US citizens and resident aliens abroad for how worldwide income and foreign tax credits work. 

Tax season readiness checklist for small business owners

It helps to be tax-ready all year to avoid surprises. Use this checklist to keep every small business income tax task aligned with IRS rules and smooth cash flow.

Following this chart all year keeps small business owners ready for every tax year deadline, trims the tax burden, and frees cash for growth.

Ready to take control of your tax burden?

Rho helps small business owners stay ahead of every layer of tax complexity. 

Connect your accounts in minutes and automatically categorize business income and expenses. Rho surfaces estimated tax obligations with reminders, manages payroll and reasonable compensation, tracks entity elections, and helps you model runway—so you’re never blindsided by a tax bill.

Get started with Rho to turn tax planning from a scramble into a steady, predictable part of growth. 

Frequently Asked Questions 

How do I choose the business structure that fits my tax profile?

Choose an entity by comparing taxes. LLCs and partnerships pass income, S corporations split salary and distributions, and C corporations lock in a 21% corporate rate but later tax dividends.

What are the current federal income tax brackets for pass‑through owners in 2025?

Personal brackets stand at 10, 12, 22, 24, 32, 35, and 37% after the standard deduction.

How do estimated tax payments work, and when are they due?

If you expect to owe more than $1,000 in taxes, you must make quarterly estimated tax payments (due April 15, June 15, September 15, and January 15). These payments cover federal income, self-employment, and applicable state taxes.

Who qualifies for the qualified business income deduction after the 2025 change?

The deduction is now permanent. Pass‑through owners qualify when taxable income stays below the IRS threshold or when wage and property tests are met.

How is self-employment tax calculated, and when does the additional Medicare surtax apply? 

Self-employment tax is 15.3% of net earnings, with half deductible, and the additional Medicare surtax of 0.9% applies when wages or self-employment income exceed $200,000 for single filers.

What triggers the economic nexus for remote sales after Wayfair?

After Wayfair, economic nexus thresholds commonly start at $100,000 in sales or 200 transactions per state, but exact thresholds vary significantly by jurisdiction.

When should I reevaluate my entity choice as income grows?

Review the entity whenever net income jumps a bracket, payroll expands, investors enter, or a new state tax law shifts the corporate or self-employment burden.

How do multistate operations affect filing and apportionment requirements?

Selling in multiple states requires tracking payroll, property, and sales factors. Apportionment splits taxable income, and each state may add franchise or gross receipts taxes, raising compliance work for small business owners.