A business captures a capital gain when it sells assets, such as buildings, land or store equipment for more than it paid for the assets. The Internal Revenue Service considers this sale a taxable transaction and assesses a progressive tax rate on most business capital gains. Businesses pay varying tax rates on all gains depending upon the tax structure of the business.
Small-business owners can use an S-Corporation, sole proprietorship or C-Corporation tax structure. A sole proprietorship allows for taxation at individual capital gains tax rates because the individual and the business are treated as the same tax entity. With an incorporated small business, the business will pay regular corporate tax rates on any capital gains, as the IRS does not distinguish between regular income and capital gains.
With a sole proprietorship, small-business owners divide their capital gains into either short-term or long-term categories. In order to receive a tax break, a business owner must wait a full year to qualify for the long-term capital gains tax. For the 2010 tax year, business owners in the 15 percent income tax bracket pay zero capital gains, and those in the 25 percent tax bracket pay 15 percent. If a business deals in collectibles, it pays a flat 28 percent capital gains tax. All capital assets bought and sold within the same year for a profit are subject to normal progressive income tax rates, which can range from 10 percent to 35 percent.
For the 2010 tax year, corporations pay a 15 percent tax on all capital gains and income between zero and $50,000. On amounts earned between $50,000 and $75,000, a small corporation pays a tax rate of 25 percent. In the highest tax bracket, small-business corporations that earn over $18,333,333 per year pay $5,150,000 in tax plus an additional 35 percent tax on all income over $18,333,333. With an S-corporation, all profit passes through to the business owner, which means that he will pay personal income tax rates on all earned income. Since capital gains are handled at the corporate level with an S-corp, the IRS taxes earned income and capital gains at the same rate.
Small-business owners in a low tax bracket benefit with long-term capital gains can benefit from significant tax savings by avoiding incorporation. For example, a business owner who earns $50,000 a year would pay $7,500 in long-term capital gains if incorporated, while she would pay nothing as a sole proprietor for the 2010 tax year.