Small Business Tax Obligations: What You're Required to Know

Why Tax Obligations Depend on Your Business Structure

Before you can understand what taxes you owe, you need to know how your business is classified. The IRS taxes different entity types differently, and the structure you chose at registration determines which forms you file, how profit is reported, and whether the business itself pays tax or the income flows to your personal return.

Most small businesses — sole proprietorships, single-member LLCs, partnerships, and S-corporations — use pass-through taxation. That means the business itself doesn't pay federal income tax. Instead, profits or losses appear on the owner's Form 1040, where they're taxed at individual rates. C-corporations are the main exception: they pay a flat 21% corporate tax rate on profits, and owners pay personal income tax again on any dividends received.

Your structure also affects your exposure to self-employment tax and how you pay yourself. See our breakdown of the financial implications of different business structures for a closer look at how each option compares.

Federal Income and Self-Employment Tax

If you operate as a sole proprietor or single-member LLC, your net business profit is reported on Schedule C attached to your personal Form 1040. That profit is subject to both regular income tax (at your marginal rate) and self-employment tax — currently 15.3% on the first $168,600 of net earnings (2024 threshold; this adjusts annually for inflation).

The self-employment tax exists because traditional employees split Social Security and Medicare contributions with their employer. When you work for yourself, you pay both halves. One partial offset: you can deduct half of the self-employment tax on your Form 1040 as an above-the-line deduction, reducing your taxable income.

Because no employer is withholding tax from a paycheck, most self-employed individuals must make estimated quarterly tax payments using Form 1040-ES. Missing these payments can result in an underpayment penalty even if you pay the full balance at tax time. The IRS generally expects four payments per year; specific due dates and calculation worksheets are included in the Form 1040-ES instructions.

Payroll Tax: What Hiring Triggers

The moment you hire your first W-2 employee, a new layer of tax obligations kicks in. As an employer, you are responsible for:

• Withholding federal income tax, Social Security (6.2%), and Medicare (1.45%) from each employee's paycheck
• Matching the Social Security and Medicare contributions your employees pay
• Depositing those combined amounts with the IRS on a monthly or semi-weekly schedule, depending on your prior-year payroll totals
• Filing Form 941 quarterly to report wages paid and taxes withheld
• Paying FUTA (Federal Unemployment Tax Act) tax, which funds unemployment programs — generally 6% on the first $7,000 of each employee's wages, often reduced by a state credit

You'll also need to issue W-2 forms to employees and 1099-NEC forms to independent contractors paid $600 or more in a calendar year, both due to recipients by January 31. Misclassifying workers — treating employees as contractors — is a common and costly mistake. Refer to IRS Publication 15-A for classification guidance.

Sales Tax and State-Level Obligations

Sales tax in the US is entirely state-administered — there is no federal sales tax. Whether you need to collect it, at what rate, and on which goods or services depends on the states where you have sales tax nexus.

Historically, nexus meant a physical presence — an office, employee, or warehouse in a state. After the Supreme Court's 2018 South Dakota v. Wayfair decision, most states also enforce economic nexus rules, which apply when an out-of-state seller exceeds a state's sales volume or revenue threshold (commonly $100,000 in sales or 200 transactions per year). If you sell online and ship to customers across multiple states, you may have nexus in more states than you realize.

States also impose their own income or franchise taxes on businesses operating within their borders. Requirements vary significantly — some states have no income tax, others impose a flat rate or a graduated structure. Check with your state's department of revenue for specifics.

Before opening, confirm that your registration and tax enrollment steps are complete. Our small business registration checklist walks through the key enrolment steps to take before you open your doors.

Recordkeeping: The Foundation of Tax Compliance

Accurate records aren't just good practice — they're a legal requirement and your best protection in an audit. The IRS generally recommends keeping records that support your income, deductions, and credits for at least three years from the date you filed the return, and longer in certain circumstances (six years if you underreported income by more than 25%; indefinitely if fraud is involved).

At minimum, maintain:

• Bank statements and credit card records
• Receipts for all business expenses
• Invoices sent and received
• Payroll records and employment tax filings
• Asset purchase records (needed to calculate depreciation)

Bookkeeping software can automate much of this, but the underlying discipline — recording transactions promptly and accurately — is on you. For a broader foundation in business finance, see our complete guide to small business finances, which covers cash flow, recordkeeping, and tax basics in one place.

This article is for general informational purposes only and does not constitute tax, legal, or financial advice. Tax obligations vary by business type, state, and individual circumstances. Consult a licensed CPA, enrolled agent, or tax attorney for guidance tailored to your specific situation.