The top 10 percent of earners pay approximately 75 percent of the entire income tax in the state. Most of these earners are small business owners.
There are approximately 30 million small businesses operating in the United States.
Small businesses of all types pay an estimated effective tax rate of 19.8 percent, according to the U.S. Small Business Association. Sole proprietorships pay 13.3 percent, partnerships pay 23.6 percent, S corporations pay 26.9 percent and C corporations pay 17.5 percent.
How federal income taxes apply to small business income depends on the type of business entity.
Sole proprietors report income and deductions on their individual federal returns. They can deduct wages and salaries paid to employees, but cannot deduct their own salaries or any business income they withdraw from the business.
Married couples who own a business together were previously treated as a partnership under federal tax laws. Starting in 2007, married couples could elect to be treated as a qualified joint venture and do not have to file as a partnership.
Partnerships are pass-through entities because the partnership is not individually subject to federal income tax. Partnership income and losses are passed through to each partner pursuant to agreed-upon allocation among partners and taxed at the partner's tax rate.
S corporations can elect to be treated as pass-through entities. Income or losses and credits are passed through to shareholders on a pro rate basis similar to partnerships. Shareholders report their share of the corporation's separately stated items of income, deduction, loss, credit and non-separately stated income or loss on their individual return.
The C corporation computes its own income or loss, files its own tax return and pays its own tax. Corporate income is again taxed to the shareholders on dividends or capital gains from the sale of their stock or upon liquidating. C corporations can deduct an owner's wages, as well as fringe benefits, such as retirement and medical reimbursement plans.
Limited Liability Companies may be treated either as a partnership with flow-through treatment or taxable as a corporation. If an LLC has one owner, it is ignored for federal tax purposes. If the LLC has
multiple owners, it files a partnership return.
The type of business entity you choose may affect how much federal and state taxes you pay. If you are starting a business or your business has changed, then re-examine whether the business entity you selected still provides the best mixture of liability protection and tax benefits.
For more information, call John D. Milikowsky at (619) 818-6799 or visit www.caltaxadviser.com.

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