How to Calculate Taxable Income of Small Businesses?

If you’ve ever had to calculate your taxable income for taxes, you’re probably already aware that it’s a complex process. Many different types of income, deductions and expenses play a role in determining how much you owe the government. If this process is new to you or if you need clarification about how much does a small business pay in taxes, read further to understand things better. 

The Methods of Calculating Taxable Income

As a small business owner, you have to pay income tax on your net income. The methods of calculating net income include:

  • Gross income – the sum total of all income earned by your business in a given period. This includes sales revenue and interest earned through bank accounts. It does not include non-sales-based sources such as tips or gifts from customers.
  • Deductible Expenses – any costs incurred by the business that is directly related to its operation and can be deducted from gross income.

Understanding Gross Profit

Gross profit is the difference between revenue and cost of goods sold. This can be an essential measure of profitability, but it’s different from net income! Gross profit doesn’t include other costs like overhead or expenses.

Gross profit is calculated by subtracting the cost of goods sold from revenue:

  • Revenue – the cost of goods sold = Gross Profit

It’s important to note that gross margin (gross profit as a percentage) and return on investment are both based on this figure alone. So if your business has no revenue or sells only one product with no COGS, then you won’t see these calculations in your financial statements!

Deducting Expenses from Gross Income

You can deduct expenses from gross income to arrive at the net taxable income of your small business. This may include:

  • Supplies
  • Equipment and machinery used in your business
  • Office supplies and other expenses related to your office space
  • The cost of equipment items that have a useful life of more than one year, such as computers and vehicles

Determining Net Income

Once you’ve calculated your gross income, use the following equation to determine your net income:

Net Income = Gross Income – Expenses

This is the number you will use to calculate your taxable income and determine how much tax you owe. It’s also called net profit or net earnings.

Paying Self-employment Tax on Net Income

Before calculating taxable income, you need to know what self-employment tax is and how it works. Self-employment tax is a Social Security and Medicare tax that’s calculated on net self-employment income. It’s 15.3% of your net self-employment income, which can get complicated if your business has losses or if you have other sources of income from another job or retirement plan (like an IRA). So, in general, if you’re running a small business as your primary source of employment, the easiest way to figure out how much self-employment tax you have to pay is by taking 15% off your total gross sales for the year.

According to Lantern by SoFi, “If your business is set up as a C corporation, it is considered a separate tax entity and is subject to its own tax rates.”

Calculating your taxable income can be challenging when you are a business owner. As we have learned today, there are many ways to calculate the amount of money you will pay in taxes each year. For most small businesses, the easiest way to do this is by using the cash-basis accounting method.