While the manner in which a small business owner must pay taxes can vary depending on the business's structure and tax elections, all small business owners must pay personal income taxes if their businesses are earning income they eventually receive at the personal level. Some businesses must pay business income taxes, and their owners also pay personal income taxes; for other businesses, taxes are only paid on the owner's individual tax return.
Determining Tax Filing Obligations
Typically, a small business owner must pay personal income taxes unless the business did not earn income or, in the case of a C corporation, the business earned income but the owner did not receive salary or a distribution. If a sole proprietorship, partnership or pass-through entity has income, then that income is recognized as personal income by the business's owner or owners. In such a case, even if no income is earned, the business owner must still file report the business's activities on her tax return.
If a business owner receives a salary from a small business, then that owner must report the salary on a personal tax return as would any employee of a business. In some situations, such as in a C corporation, salary must be reported on a W-2 at the end of the tax year. For the owners of an LLC, salary may instead come in the form of "guaranteed payments," which must also be reported on a personal income tax filing.
In addition to salary, small business owners pay personal income taxes on profits that flow through from the business. A sole proprietor, for example, must report business income or losses on Schedule C to her personal income tax return. A partnership must complete a partnership return and provide Form K-1 for each partner, which is then reported on the individual's income tax return. LLC income is reported based on the tax election of the owners, but a small business LLC would typically be taxed as a sole proprietorship or partnership.
Capital Gains and Dividends
When a small business has been formed as a C corporation, then business profits do not automatically flow through to the business owner's personal income. Instead, any personal taxable income would be the result of a payment from the corporation. As mentioned above, such payment can take the form of salary. Additionally, the business could pay distributions in the form of dividends, which would then be taxable on the personal returns of the dividend recipients. Finally, if a business owner sells a part of a business by transferring stock, then capital gains taxes may be owed.