Tax Basics for Businesses

Taxes are nothing if not two things: essential and complicated. They serve as the foundation for funding government at all levels of the United States. They also rank among the most contentious issues businesses face.

According to the Tax Foundation, an independent nonprofit that examines tax policy, U.S. businesses collect and pay more than 93% of the total taxes that federal, state and local governments receive annually. These include both direct taxes paid by businesses themselves and the taxes they collect and remit, such as state and local sales taxes and their workers’ share of income and employment taxes.

At the federal level, the Internal Revenue Service oversees the collection of taxes from both businesses and individuals. Most businesses are required to pay income taxes, either at the corporate tax rate or, in the case of many small businesses, at the individual tax rate. Businesses also pay numerous other taxes, including employment taxes, excise taxes, sales taxes, and, when a business owner transfers ownership to heirs, estate or gift taxes.

The COVID-19 pandemic has added some additional complexity to the U.S. Tax Code, as lawmakers have sought to offer tax breaks such as a child tax credit to spur economic recovery and encourage the hiring and retention of workers.

The following is a closer examination of some of the recent developments surrounding the corporate tax rate and other taxes, including estate taxes and capital gains taxes, as well as the tax impacts of the pandemic.

Corporate tax rates

Incorporated companies, known as “C corporations,” are taxed separately from their owners and pay corporate income taxes at the federal level and in most states. Other types of businesses, known as “passthroughs,” are taxed at individual tax rates. These passthrough entities include S corporations, partnerships, limited liability companies (LLCs) and sole proprietorships.

The corporate tax rate is the percentage of a company’s taxable income (revenues minus cost of goods sold, general and administrative expenses, and other operating costs) that incorporated businesses must pay to the IRS. Following the passage of the Tax Cuts and Jobs Act of 2017, the rate was reduced to 21% from a previous level of 35%.

Recently businesses have expressed concern about the possibility that the corporate tax rate could be increased above its current rate in order to help fund proposed government spending. Some proposals have called for rates of 25% or 28%.

Estate taxes

Among the more contentious taxes is the estate tax, derisively referred to as the “death tax,” which is levied on the value of assets when the owner dies and transfers the assets to heirs. In addition to federal estate taxes, a handful of states also charge an estate tax. Some states also collect an inheritance tax, which is paid by those who inherit the assets.

Family-owned businesses in particular have long fought against the estate tax, which currently exempts estates valued at less than $11.7 million. It is set to revert to the previous threshold of $5 million in 2026. However, some recent proposals have called for setting a threshold of $3.5 million in order to raise more money to fund federal spending plans on infrastructure.

Assets transferred to heirs before a person’s death aren’t subject to an estate tax, but they could be subject to a separate federal gift tax.

Capital gains taxes

Businesses, like individuals, also pay taxes when they sell their investments or assets. Known as capital gains taxes, businesses are subject to them at both the federal and state level, making these taxes the source of extensive political debate.

Among the arguments against capital gains taxes is that they discourage investment on multiple levels, including dissuading investments that help businesses grow. In addition, capital gains taxes may discourage businesses from selling certain assets, thus minimizing their overall potential revenue.

The top federal rate for long-term capital gains taxes (i.e., assets held for more than a year) is currently 23.8%, although the Biden Administration reportedly has been considering raising the rate to 39.6% as part of its American Families Plan.

Pandemic-related tax relief

Amid the COVID-19 pandemic, government leaders enacted tax relief aimed in part at reimbursing businesses for some pandemic-related costs and to encourage them to retain workers.

The American Rescue Plan Act of 2021 allows small and medium-sized businesses to claim federal tax credits to refund the costs of providing paid sick and family leave because of COVID-19. The relief covers paid sick and family leave from April 1 through Sept. 30 of this year. Coverage also includes a vaccine tax credit to encourage businesses to grant time off so their workers and their families can get vaccinated.

Separately, the Employee Retention Tax Credit, which was enacted at the start of the pandemic in March 2020, has been extended through the end of 2021, though the benefit could end earlier if the infrastructure bill passes. Eligible companies can receive as much as $7,000 per employee per quarter in 2021, for a potential total of $28,000 per employee for the full year.

Tax resources

Business taxes are complicated and ever-changing, requiring companies to pay careful attention to ensure they are achieving the maximum tax benefits available to them while at the same time operating within federal, state and local tax laws.

Businesses may find the additional resources helpful when it comes to navigating taxes:

• Overview of business tax issues
• Business tax strategies that can save money
• IRS Small Business and Self-Employed Tax Center