What's the Difference Between Federal and State Business Taxes?

Every business pays a variety of taxes to the federal government and the state of California. The type of tax, the structure of the business, and the amount of money received or earned dictates the amount of the tax.

The following post outlines the various taxes collected by the state and federal governments, the tax rates, and how often the taxes must be paid. The information is provided by business structure since that is the main dividing point for finding tax information.

Overview of Types of Federal and State Taxes

The federal government collects the following types of business taxes:

• Business income tax
• Employment taxes including Social Security, Medicare, federal income tax withholding, and federal unemployment tax (FUTA)
• Self-employment tax including Social Security and Medicare tax for individuals working for themselves

The state of California collects the following business taxes:

• Corporate taxes
• Franchise taxes
• Alternative minimum tax (AMT)
• Employment taxes including unemployment insurance, employee training taxes, state disability insurance including paid family leave

In each case, the tax rate is based on the type of business you operate, the earnings and income from that business, and the structure of your business.

Federal and State Business Income Tax

All businesses except partnerships must file income tax returns annually. There is a different federal return for each type of business structure.

Corporations (C-Corporations)

Corporations or C-Corporations pay income tax and take the same deductions as a sole proprietorship to determine taxable income; the corporation as a whole is treated as a separate and individual entity. It is even eligible for special deductions. However, it cannot get a tax deduction when it distributes dividends to its shareholders.

Corporations must file an income tax return by the 15th day of the fourth month after the end of its tax year. Exceptions to that schedule include corporations that have dissolved and those with a fiscal year ending on June 30; in these cases, special filing dates apply.

Tax rates for corporations start at 15% for those businesses with a taxable income of zero to $50,000 up to 35% for taxable income of $18,333,333 and over.

S-Corporations

Per the IRS, S-corporations pass through business income and losses to the personal income tax returns of the shareholders. The income is then assessed at the individual income tax rate and the S-corporation or LLC avoids double-taxation on corporate income.

However, the State of California imposes both business and personal income taxes on small business owners who set up businesses as pass-through entities such as S-corporations and LLCs.

Limited Liability Companies

LLCs are regulated by state law. In California, the net income from an LLC passes through to the business owners just as with an S-corporation. See S-Corporations above regarding double taxation and the State of California.

Sole Proprietorship

A Sole Proprietorship is not considered a corporation. All income is reported on the individual’s personal income tax return.

Employment Taxes: Federal and State

Sole proprietors, partnerships, C-corporations, S-corporations, and Limited Liability Companies must pay employment taxes if they have people working for them. Employment taxes are collected by both the IRS and the Employee Development Department of the State of California and are only paid by businesses with employees working for a wage or salary.

By default, the IRS considers a Sole Proprietorship as both  employee and  employer; therefore the individual must pay both the employee and employer share of Social Security and Medicare taxes, also known as the Self-Employment Tax.

All employment taxes are filed quarterly.

Federal employment taxes include:

• Social Security: for 2017, the employee and employer tax rate is 6.2% for a total rate of 12.4%. Sole Proprietors must pay the full 12.4%. The wage base limit is $127,200.
• Medicare: for 2017, the employee and employer tax rate is 1.45% for a total rate of 2.9%. Sole Proprietors must pay the full 2.9%. There is no wage base limit.
• Federal Unemployment Tax (FUTA): for 2017, the tax rate is 6% on the first $7,000 paid to each employee. If you must also pay into a state unemployment insurance fund, you may get a tax credit against your FUTA up to 5.4% of FUTA taxable wages. FUTA only applies if the business paid one or more employees and does not apply to a Sole Proprietorship or members or shareholders of a partnership or LLC.

State employment taxes in California include:

• Unemployment insurance: paid by the employer. For new employers in 2016, the rate was 3.4% for the first $7,000 in wages per employer in the calendar year. An experience employer’s rate varies based on the employer’s experience and balance in the unemployment insurance fund. Rates may vary from year to year.
• Employee training tax: paid by the employer. For 2016, the rate was 0.1% on the first $7,000 in wages per employee in the calendar year. All new employers pay in their first tax year; afterward, those with negative reserve account balances do not pay.
• State disability insurance and paid family leave: paid by the employee. The rate and taxable range limit may change annually. For 2017, the withholding rate is 0.9% on the first $110,902 per employee for the calendar year up to a maximum of $998.12.

California State Business Taxes

In addition to income and employment taxes, the State of California also collects the following:

• Corporate Tax: paid to the Franchise Tax Board. For 2017, the rate is 8.84% of a traditional or C-corporation’s net taxable income from business activity in the state. Different rates apply for financial entities.
• Franchise Tax: paid to the Franchise Tax Board. S-corporations are taxed at a rate of 1.5% of net income with a minimum of $800 if zero or negative income is claimed. LLCs are treated differently depending on whether they are considered as a disregarded entity, a corporation, or a partnership.
• Alternative Minimum Tax: paid to the Franchise Tax Board. For 2016 the rate was 65% based on the federal AMT rate. It only applies to C-corporations and LLCs electing to be treated as corporations.

While the federal government and the state of California collect business income and employment taxes, California imposes higher average income tax rates on both business and personal income. Also, the state does not consider collecting income tax on both the business income of a pass-through business and its owner’s personal income tax as double-taxation.

In California, both the business income and the personal income derived from the pass-through S-corporation or LLC are taxed. California also charges C-corporations corporate tax or AMT depending on whether taxable income is claimed as well as taxing the personal income of shareholders at marginal tax rate of 33%. Pass-through marginal income tax rates range from 1% to 12.3% depending the individual’s tax bracket, of which there are nine.

Doing business in California can be an expensive proposition for small businesses and entrepreneurs. Consulting with an experienced California tax attorney can help you determine your best path to success.