Can a Small Business Get a Tax Refund?
When you send more tax dollars to the federal or state government than you owe, you may be eligible for a tax refund. This is true for individual taxpayers, but do businesses get tax refunds?
Refunds for businesses aren’t as common as refunds for individuals. That’s because, depending on the business entity type, the business might not pay federal or state income taxes directly. Still, your small businesses can get a tax refund in some situations. We’ll help you figure out whether your company qualifies and how to get a tax refund for small business.
What’s your business entity type?
Most small businesses don’t pay income taxes directly. That’s because 95% of the roughly 26 million businesses in the U.S. are pass-through entities. Pass-through businesses, which include sole proprietorships, partnerships, limited liability companies (LLCs) and S corporations, may file business tax returns, but they don’t pay federal income taxes to the IRS. Instead, their profits “pass-through” to the owners’ personal tax return, and the business owner or owners pay taxes rather than the business.
If you own a pass-through business, you may be required to pay federal and state income taxes throughout the year, either by having it withheld from your paychecks or making quarterly estimated payments. If your withholding or estimated payments are greater than the tax calculated due on your return, you can receive a personal tax refund.
C corporations are the only business entity type that pays income taxes directly to the federal government. If you own a C corporation, you must make quarterly estimated payments if the company expects to owe tax of $500 or more once you file the business tax return. The company can get a business tax refund for any overpayment.
Here’s a brief overview of how different types of businesses pay taxes.
- Sole proprietorship: Sole proprietors don’t file separate business tax returns. Instead, the owner reports business income and expenses on form Schedule C filed with their personal tax return.
- Partnership: Partnerships file Form 1065 to report business revenues and expenses but they don’t pay taxes directly to the IRS. Instead, each partner receives a Schedule K-1 reporting their share of the company’s profits, and they use the information on Schedule K-1 to complete their personal tax return and pay any tax due.
- Limited liability company: LLCs can file tax returns in several different ways. LLCs with only one member (also known as “single-member LLCs”) use Schedule C to report their business income and expenses to the IRS, just like sole proprietorships. LLCs with more than one member (also known as “multi-member LLCs”) use Form 1065 to report business income and deductions to the IRS, just like a partnership. LLCs may choose to be taxed as a pass-through entity or a corporation.
- S corporation: S corporations file federal income taxes using Form 1120S. Like partnerships, S corporation shareholders receive a Schedule K-1, which they use to complete their personal tax return and pay taxes on their share of the business’s profits.
- Corporation: C corporations file federal income taxes using Form 1120 and pay federal income taxes directly to the IRS.
Understanding the small business tax rate
Businesses pay different tax rates based on their structure.
C corporations pay federal income taxes at a flat rate of 21%, but the tax rate isn’t as simple for pass-through business owners. Pass-through business owners pay taxes on all the income included in their personal tax returns — not just business profits. Wages from a job, investment income, and Social Security benefits affect the tax rate you’ll pay on business profits.
Tax rates on personal tax returns are progressive, meaning the higher your taxable income, the higher your tax rate will be. In 2021, there are seven tax brackets ranging from 10% to 37%.
Which business entity could provide the best tax advantages?
With corporations paying a flat rate of 21% and pass-through business owners potentially subject to a 37% rate on business profits, it might seem as though incorporating provides greater tax advantages. However, several factors might influence your choice of business entity.
- Pass-through deduction. The pass-through deduction allows some owners of pass-through businesses to claim a deduction worth up to 20% of their qualified business income. This essentially allows businesses to pay a top tax rate of 29.6% on business profits.
- Double taxation. Corporations are subject to “double taxation,” meaning the business pays taxes on profits, and then shareholders are taxed again on those profits when they’re received in the form of dividends.
- Self-employment tax. Sole proprietors, partners, and LLC members must pay self-employment taxes on business profits on top of their regular income tax. Self-employment taxes are the self-employed version of Social Security and Medicare taxes, commonly known as “FICA tax.” Corporate shareholders don’t pay self-employment taxes. Instead, they receive a salary from the company and have FICA taxes withheld from their paycheck.
Types of business taxes
Federal income taxes tend to get the most attention from small business owners, but they’re far from the only taxes that small business owners must pay. Some other types of business taxes include:
Besides federal income taxes, many states levy income taxes on individuals and businesses. Currently, 41 states tax wages, salaries and self-employment income. Only New Hampshire exclusively taxes dividend and interest income. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming don’t levy an income tax.
However, Nevada, Ohio, Texas and Washington impose a gross receipts tax instead of a corporate income tax. Delaware and Oregon levy a gross receipts tax in addition to corporate income taxes.
Businesses with employees must report and deposit federal and state payroll taxes. This includes federal and state income tax withholding, FICA taxes and federal and state unemployment taxes.
Self-employment taxes are the Social Security and Medicare taxes paid by self-employed business owners. Sole proprietors, partners in a partnership, and LLC members must pay self-employment taxes on self-employment earnings of $400 or more.
Sales or excise taxes
Many states and localities levy a sales tax on transactions of goods and services. The federal government also levies excise taxes on certain goods and services, including fuel, airline tickets, heavy trucks and tractors, indoor tanning salons and tobacco. Business owners need to calculate, collect and remit sales and excise taxes to their federal, state or local taxing authority.
Reducing your taxable income
While getting a tax refund may sound enticing, it’s typically more beneficial for small business owners to reduce their tax liability by taking advantage of various tax deductions.
The IRS generally considers an expense to be deductible if it’s “ordinary and necessary.” An ordinary expense is common and accepted in your line of work. A necessary expense is helpful and appropriate under the circumstances.
While ordinary and necessary expenses for your small business depend on your industry and unique business needs, some common examples include:
- Advertising and marketing
- Bank fees
- Business insurance
- Dues and subscriptions
- Employee benefits
- Interest expense
- Legal and professional fees
- Repairs and maintenance
- Salaries and wages
- Taxes and licenses
You can find more examples of deductible business expenses and rules for claiming them in IRS Publication 535.
Frequently asked questions
Can a small business get a tax refund?
Most small businesses don’t receive IRS refunds because they don’t pay taxes – at least not directly. Pass-through businesses, including sole proprietors, partnerships, LLCs and S corporations, may file tax returns, but taxable income passes through to the owner or shareholder’s personal tax return. Only C corporations pay taxes directly and can receive IRS refunds if their estimated tax payments are greater than their actual tax liability for the year.
Do LLCs get tax refunds?
Generally, no. However, LLCs can elect to be treated like C corporations for tax purposes by filing Form 8832. If an LLC elects C corporation status and makes quarterly estimated payments higher than its tax liability for the year, the LLC can receive a tax refund.
Do I get a tax refund if I am self-employed?
Self-employed taxpayers who overpay their estimated taxes can get a tax refund. They can also choose to have all or part of their overpayment applied to the following tax year, potentially reducing the estimated payments required in the next year.
What other taxes does a business pay?
Small business owners may also be required to pay other federal, state and local taxes, including self-employment taxes, payroll taxes, state and local income taxes, excise taxes, property taxes and sales taxes. The type of taxes a small business pays depends on its location, industry rules and whether the business has employees.