business taxes - marketing
TRANSCRIPT
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 1
LAPLeadership, Attitude, Performance...making learning pay!Economics LAP 27 Performance Indicator: EC:072 Student Guide
Explain the importance of taxes to the government and the economy.
Objectives:
1375 King Avenue, P.O. Box 12279, Columbus, Ohio 43212-0279 Ph: (614) 486-6708 Fax: (614) 486-1819
Details: www.MBAResearch.org Copyright ©2014 by MBA Research and Curriculum Center®
Business Taxes
Pay Your Share Tax Basics
Describe the different types of taxes businesses must pay.
Now It’s Time to Pay
Why bother learning about business taxes?
What would you do?
Use what you’ve learned—right now!
Table of Contents
2
8
2
7
17
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 2
As a student, you might not worry
too much about paying taxes right
now. If you have a part-time job,
you’ve probably noticed that your
employer deducts taxes from your
paycheck, but you might not un-
derstand why or where the money
is going. As the famous old saying
goes, “Nothing is certain except
death and taxes.” Like it or not,
you’ll have to pay taxes throughout
your career and adult life. Individu-
als like you aren’t the only ones
who are responsible for paying
taxes—businesses pay them, too!
Learn more about why businesses
pay taxes and what types of taxes
they pay.
Tax BasicsSuper market
To learn the impact of taxes on individuals, businesses, and government in the
United States, you must first understand the market economy we live in.
A market economy is an economic system based on private enterprise. In a
private enterprise system, businesses compete against each other to win
scarce customer dollars, with limited restrictions or government intervention
(in theory, anyway).
Let’s take a quick look at some important roles in a market economy:
• Businesses. When a business is successful in a market economy, it generates more sales and more income, both of which create bigger tax revenues for the government.
• Individuals. When individuals become successful in a market economy, they earn greater personal incomes, which generate more tax revenue for the government, and contribute to business growth through spending.
• The government. The government contributes to a market economy by spending the money it collects in taxes. As a matter of fact, in the U.S., about one third of our economy is based on government spending.
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 3
Can you see how all the players in a market economy are connected and interdependent? Let’s investigate
a little further by looking at the circular flow of income model.
The circular flow of income model is a very simplified depiction of how money flows through a market
economy. It shows money going back and forth between consumers and businesses. Consumers pay
businesses for goods and services, and businesses channel money back to consumers by expanding,
hiring, and paying salaries to employees (and, in some cases, paying dividends to shareholders).
Factors of Production
Wages, Rent, Interest, or Profit
Consumer Spending
Consumers
Goods and Services
Icon credits: iStock/Thinkstock
Businesses
Circular Flow of Income Model
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 4
As you can probably guess, though, the economy doesn’t exactly work this way in
real life. There are always leakages in this circular flow. For instance, consumers don’t
spend all their money on goods and services—they might save some for the future or
buy imports (products from outside the domestic economy). Businesses don’t use all
their profits for paying employees or shareholders, either. They may retain some earn-
ings to reinvest in the business or to pay off debt. And, of course, the government inter-
rupts the circular flow when it levies taxes on both individuals and businesses. Even
though the government puts money back into the economy by spending, it’s often not
enough to cover these leakages. When this happens, the government may attempt to
create an inflow of cash by borrowing from foreign investors or by trying to increase
the economy’s exports.
Tax...
Federal, state, and local governments all levy taxes on individuals and businesses.
We’ll learn more about the specific types of taxes businesses must pay later in the
LAP, but here are a few quick facts on where most of the government’s tax revenue
comes from:
• Individual income taxes make up about 46 percent of federal tax revenue and 37 percent of state/local tax revenue.
• Business income taxes make up about 11 percent of federal tax revenue and 7 percent of state/local tax revenue.
• Payroll taxes (paid jointly by employees and employers) make up about 35 percent of federal tax revenue.
• Sales and property taxes make up about 30 percent of state/local tax revenue.
(The federal government does not levy sales and property taxes.)
Imports and exports cause some leakages in the circular flow of income model. Saving for the future, reinvesting in the business, and paying taxes also cause “hiccups” in the flow of money in the economy.
iStock/Thinkstock
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 5
For a more in-depth look at government tax revenues, check out the Center on Budget
and Policy Priorities’ website at http://www.cbpp.org/cms/?fa=view&id=3822 or the Tax
Policy Center’s breakdown at http://www.taxpolicycenter.org/briefing-book/state-local/
revenues/state_revenue.cfm .
...and spend...
So, how does the government use all this tax revenue? To answer this question,
let’s take a look at both the federal government and state/local governments.
The federal government. The federal government divides its tax revenue into two
parts—income taxes (both individual and business) and payroll taxes (if you don’t know
what these are, don’t worry—we’ll go over it in Objective B). Income taxes become
general funds. The President and Congress can spend these funds however they see fit.
Payroll taxes become trust funds. This means that they are designated for specific
uses and cannot be spent on anything else. In the U.S., the majority of these trust funds
pay for unemployment, Social Security, and Medicare benefits. Social Security is a
federal program intended to keep elderly and disabled people from living in poverty.
Medicare is a program that provides health care for the elderly and disabled.
The biggest single chunk of the federal government’s spending goes to unemploy-
ment, Social Security, and Medicare. In 2010, these programs accounted for about
35 percent of federal spending. Other social programs (e.g., student loans, emergency
food assistance, etc.) accounted for 25 percent. National defense, veterans, and foreign
affairs accounted for 24 percent. The rest went toward human and community develop-
ment, law enforcement, general government, and interest on the national debt.
Payroll taxes levied by the federal government become trust funds that are used to pay for Social Security, Medicare, and unem- ployment benefits.
iStock/Thinkstock
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 6
For more information on federal spending, look at the National Priorities Project’s
Federal Budget 101 links, starting here—http://nationalpriorities.org/budget-basics/
federal-budget-101/spending/ .
State and local governments. State and local governments use
their tax revenue for a number of purposes, including:
• Education
• Welfare
• Medicaid (low-income health-care coverage)
• Police, fire, and emergency medical services
• Water and sanitation
• Transportation
• Housing
• Parks, recreation, and libraries
• Interest on debt
You can look up more data about your state’s spending here—
http://www.usgovernmentspending.com/compare_state_spending_F0p.
...and borrow
The U.S. federal government’s predicted tax revenue for the year 2014 is
approximately $3 trillion. In case you were wondering, that’s a three followed by
twelve zeroes. When tax revenue isn’t enough to cover government expenditures,
the U.S. Treasury must borrow money. In 2014, that amount is expected to be about
$616 billion. Eventually, it will all have to be paid back—with interest.
Many state and local governments “give back” to their citizens by using a portion of their tax revenue to build public parks and other recreational facilities.
iStock/Thinkstock
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 7
1. What is a market economy?
2. What are the roles of businesses, individuals, and the government in a market economy?
3. Describe the circular flow of income model.
4. Where does the government’s tax revenue come from?
5. How does the government spend tax revenue?
6. What happens when tax revenue isn’t enough to cover government expenditures?
Certain loopholes in the tax code can allow individuals or businesses to get away with paying much lower tax bills than they technically owe. One of the most common tax loopholes involves companies that operate in both the U.S. and for-eign countries leaving their profits overseas to avoid taxation. You see, companies don’t have to pay in-come taxes on foreign profits until they transfer them back to the U.S. So, a lot of companies just leave the money in overseas “tax havens.” It’s estimated that the federal government misses out on about $100 billion a year in tax revenue due to this practice. It’s legal, but is it ethical? What do you think?
Summary
Individuals, businesses, and the government all play important roles in a market
economy. Individuals and businesses make money and pay taxes, and the
government puts money back into the economy through spending. Taxation is
just one of the leakages in a market economy’s circular flow of income model.
Federal, state, and local governments tax individuals as well as businesses.
This tax revenue is used for a number of purposes, including Social Security,
Medicare, national defense, education, transportation, etc. When tax revenue
isn’t enough, the government borrows money to cover its expenditures.
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 8
Now It’s Time to PayBusinesses are responsible for paying a number of different types of taxes. Business
taxes may seem confusing at first, and, yes, the tax code can be a dense read even
for professionals, but anyone pursuing a business career should try to understand the
basics. Let’s take a closer look at the different types of taxes businesses must pay.
Income taxes. Businesses must pay income taxes on the profits they make, just
as individuals are required to do. The federal government as well as state and local
governments levy income taxes on businesses. Depending on how much profit a
business makes, the federal income tax rate is anywhere from 15 to 35 percent.
The more profit a business makes, the higher its tax rate is on the amount of profits
over a certain dollar figure. Don’t worry—it’s simpler than it sounds. Here’s a chart
that should help you understand:
Taxable Income (Profits) Federal Tax Rate (2011)
$0 to $50,000 15%
$50,000 to $75,000 $7,500 plus 25% of the amount over $50,000
$75,000 to $100,000 $13,750 plus 34% of the amount over $75,000
$100,000 to $335,000 $22,250 plus 39% of the amount over $100,000
$335,000 to $10,000,000 $113,900 plus 34% of the amount over $335,000
$10,000,000 to $15,000,000 $3,400,000 plus 35% of the amount over $10,000,000
$15,000,000 to $18,333,333 $5,150,000 plus 38% of the amount over $15,000,000
$18,333,333 and higher 35%
The deadline for corporate tax returns is typically March 15th of each year, while individual tax returns are due by April 15th.
iStock/Thinkstock
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 9
So, according to the chart, if your business made $500,000 in profits last year, you
would pay $113,900 plus 34 percent of $165,000 (the amount you made over $335,000).
Thirty-four percent of $165,000 is $56,100. Therefore, your business would owe
$170,000 in federal income taxes. Choose another dollar figure to represent taxable
income, and try doing the calculations yourself.
As far as state income taxes for businesses go, the rates vary from state to state.
Some states, such as Maryland, charge only a flat tax (every business pays the same
percentage, no matter how much profit it makes). Other states, such as Utah, use a
graduated scale similar to the one the federal government uses. And four states—
Nevada, South Dakota, Washington, and Wyoming—levy no income taxes on
businesses at all.
This chart compiled by The Tax Foundation shows how business tax rates have
changed over the years — http://taxfoundation.org/article/federal-corporate-income-
tax-rates-income-years-1909-2012.
Payroll taxes. There are taxes associated with being employed as well as with being
an employer. These are known as payroll taxes. Employers must withhold certain
taxes from their employees’ paychecks. These include the employees’ federal, state,
and local income taxes as well as Social Security and Medicare taxes. The Social
Security tax is listed on an employee’s pay stub as FICA, in reference to the Federal
Insurance Contributions Act that authorizes the tax. The current FICA tax rate is
6.2 percent of an employee’s gross wages. The current Medicare tax is 1.45 percent
of an employee’s gross wages.
There are many loopholes in the tax code that allow busi-nesses to achieve lower tax rates. It’s not uncommon for two businesses that earn the same amount of profits to pay very different amounts in taxes. The Institute for Policy Studies has compiled an interesting list of some common loopholes here— http://www.ips-dc.org/reports/corporate_tax_dodgers .
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 10
Employers must pay a matching amount of FICA tax and Medicare tax for each
employee. The federal government, then, receives FICA tax in the amount of 12.4
percent of each employee’s gross wages and Medicare tax in the amount of 2.9 per-
cent for each employee’s gross wages. Half is paid by the employee, and half by
the employer. Make sense? In addition, employers pay taxes to fund unemployment
and workers’ compensation programs.
Self-employment taxes. Self-employment taxes are the equivalent of payroll
taxes for those who own their own businesses. Let’s say you work as a house
painter, going from job to job as you get hired. Even though your clients pay you,
they aren’t your employers. They won’t withhold any taxes from your earnings, nor
will they pay half of your Social Security and Medicare taxes. You’ll have to do that
yourself.
To make up for the missing employer contribution, self-employed people must
pay the entire 12.4 percent Social Security tax and 2.9 percent Medicare tax them-
selves. However, they may deduct half the amount from their taxable incomes as a
business expense (we’ll explain deductions in just a bit). Self-employed people must
also withhold their own income taxes and make estimated payments to the govern-
ment every three months.
Watch this video for more information and tips on paying self-employment
taxes — http://video.foxbusiness.com/v/2260954350001/last-minute-tax-tips-for-the-
self-employed/ .
Listen Up!
Five states do not levy state
sales taxes—Alaska, Delaware,
Montana, New Hampshire, and
Oregon. Eleven states do not
allow local sales taxes—Con-
necticut, Delaware, Indiana,
Kentucky, Maryland, Massachu-
setts, Michigan, New Hamp-
shire, Oregon, and Rhode Is-
land. So, that makes your retail
purchases in Delaware, New
Hampshire, and Oregon com-
pletely tax free!
iSto
ckph
oto/
Thin
ksto
ck
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 11
Excise taxes. For certain products, the government levies taxes that businesses
pay by building the amount into the customer’s purchase price. In other words,
instead of charging a tax in addition to the product’s price, the business just
charges a higher price to begin with, using the difference to pay the required tax
to the government. These are known as excise taxes. Examples of products that
carry excise taxes include gasoline, air travel, mobile phone services, alcohol,
tobacco, indoor tanning, and some luxury items such as boats.
Property taxes. Businesses must pay property taxes just as individuals do.
Property taxes are based on a percentage of the property’s value. They usually apply
to real estate, though sometimes businesses pay property taxes on their vehicles or
even their inventories. Typically, property taxes are levied by city or county govern-
ments and used to fund schools, road construction, and other local interests.
For a map of states that levy taxes on business inventories, click here—
http://taxfoundation.org/blog/monday-map-property-taxes-business-inventory .
Sales taxes. You know that when you buy a pair of jeans for $59.99, your total is
a few dollars higher than that. That’s because of the sales tax, a tax levied by state
and local governments on most retail products. Sales taxes are a percentage of the
total purchase price. So, if you buy $59.99 jeans where the state sales tax is 6.5 per-
cent and the local sales tax is 2 percent, you’ll pay $59.99 + $3.90 + $1.20 = $65.09.
Businesses are responsible for collecting sales taxes from customers and turning
them over to the appropriate governments. As far as businesses themselves, they
do not have to pay sales taxes on the items they purchase for resale. However, they
do pay sales taxes on products they purchase for use in operating the business (e.g.,
shelving, computers, office supplies, etc.).
In addition to deductions
for business expenses, some
companies can lower their
tax bills by qualifying for
certain tax breaks. Tax
breaks are indirect
government subsidies
(financial support aimed at
creating economic or social
benefits). For example, a lo-
cal government might give
a certain business or group
of businesses a tax break to
operate in its town or city.
The goal would be to attract
businesses and create jobs.
Give Me a Break!
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 12
Don’t forget your deductions!
It may seem that businesses owe an awful lot in taxes, but
there are certain ways they can save money. Business owners
can count certain expenses as deductions from their taxable
income, lowering their tax bills. Here are just a few examples
of expenses that businesses can deduct:
• Start-up costs
• Vehicles
• Travel expenses
• Equipment expenses
• Advertising and promotion expenses
• Salaries and bonuses paid to employees
• The costs of benefits paid to employees (health care, 401k contributions, etc.)
• The costs of payroll taxes (the business’s matching amounts of FICA and Medicare contributions)
Here’s a simplified example. Let’s say your company made
$1 million in sales revenue last year, but it cost $750,000 to
keep the business running as a result of paying for salaries,
rent, equipment, etc. Your business will pay income taxes
only on the $250,000 in profits, not the entire $1 million
in revenue.
Small business owners typically claim their business profit or loss on their
personal tax returns. To lower their tax bills, they usually deduct their
business expenses (such as advertising, work vehicles, equipment, etc.)
from their taxable income.
iStock/Thinkstock
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 13
The Internal Revenue Service gives additional information on business
deductions here — http://www.irs.gov/Businesses/Small-Businesses-&-Self-Em-
ployed/Deducting-Business-Expenses .
You need some structure
A business’s ownership structure affects the way it is taxed. There are several
different types of business structures, but when it comes to taxes, the main
thing to know is whether or not the business is a corporation.
Non-corporations. Sole proprietorships (businesses owned by one individu-
al), partnerships (businesses owned by two or more individuals), and limited
liability companies (partnership-corporation hybrids) are all taxed similarly.
They are considered pass-through entities, meaning that all of the business’s
profits and losses are “passed through” to the owner(s) to be claimed on their
personal tax returns. Each owner’s individual portion of the business’s profits
and losses is known as her/his distributive share.
Business owners must pay taxes on their distributive shares whether or not
they withdraw money from the business. Let’s say you’re a partner in an LLC,
and your distributive share last year was $100,000. You take half that money
out as your “salary,” and leave half of it invested in the company. Even though
you only took home $50,000 in pay, you’ll still be taxed on the entire $100,000.
This is the reason that some business owners find it advantageous to change
the business’s structure and incorporate (become a legal corporation).
“Taxes are what we pay for civilized society.”
— Oliver Wendell Holmes, Jr.,
U.S. Supreme Court Justice
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 14
Here are a few more important things to note about non-corporations and taxes:
• There is no tax withholding for owners of these types of businesses. The owners are considered self-employed and must make quarterly estimated tax payments to the government.
• Businesses with multiple owners must file informational returns with the Internal Revenue Service to ensure that all partners are filing their individual returns correctly.
• Even though owners pay only personal taxes, they can still deduct business expenses from their taxable incomes. This makes accurate recordkeeping extremely important. It’s a good idea for owners to keep separate business and personal accounts.
Corporations. Corporations are the only businesses that are separate entities
from their owners and pay their own income taxes. Like other businesses,
corporations make estimated quarterly tax payments to the government.
The main advantage of the corporate structure is that the business can retain its
earnings at lower tax rates than individual owners can. If you refer back to the table
of corporate tax rates above, you can see that tax rates for a business’s first $75,000
in taxable income range from 15 to 25 percent. These rates are lower than what
owners would pay on their personal tax returns for distributive shares. Corporation
owners pay taxes only on their salaries and dividends. They are also protected from
shouldering personal liability for the corporation’s losses.
Most corporations are known as
C corporations. An S corporation,
however, is a special type of corpo-
ration that chooses to be taxed as a
pass-through entity. There are several
limitations regarding what an S
corporation can be. For example,
it must be a domestic corporation
with no more than 100 shareholders.
iStock/Thinkstock
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 15
Double Taxation
The main disadvantage of the corporate structure is double taxation. After the corporation
pays income taxes on its earnings, it may distribute dividends to shareholders. The shareholders
then report those dividends on their personal tax returns, paying income taxes on them as well.
This video explains more about business structures and tax implications—
http://www.videojug.com/interview/small-business-types-and-their-tax-implications .
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 16
The IRS
The government agency that oversees taxes is the Internal Revenue Service,
or IRS. Headquartered in Washington, D.C., the IRS operates under the authority
of the U.S. Department of Treasury, and its major duties include:
• Checking tax returns
• Collecting tax payments
• Issuing tax refunds
• Conducting tax audits
Different divisions of the IRS specialize in individual taxpayers, small businesses,
medium to large businesses, and non-profit organizations.
Summary
Businesses may be responsible for paying a number of different taxes, including
income taxes, payroll taxes, self-employment taxes, excise taxes, property taxes,
and sales taxes. Businesses can deduct certain expenses from taxable income to
lower their tax bills. A business’s ownership structure affects the way it is taxed.
Non-corporations are “pass-through” entities, but corporations are taxed separately
from their owners. The Internal Revenue Service is the government agency that
oversees taxes.
1. What types of taxes apply to businesses?
2. How can businesses save money on taxes?
3. How does a business’s structure affect the way it is taxed?
4. What is the role of the Internal Revenue Service?
LAP-EC-027-SP © 2014, MBA Research and Curriculum Center® Pay Your Share 17
Think about your place of employment. If you aren’t
working right now, consider where a parent/guardian
works or perhaps a local business you visit frequently.
What is the ownership structure of this business? How
does this structure affect the way the business is taxed?
What types of taxes are the business or its owners
likely to pay?