Taxes When You Start a Business

Starting a business is exciting, but it comes with a new set of tax obligations that can catch first-time business owners off guard. Understanding the basics from the start saves money and avoids penalties.

The most significant new tax for business owners is self-employment tax — 15.3% on the first $168,600 of net self-employment income (in 2024), consisting of 12.4% for Social Security and 2.9% for Medicare. This replaces the payroll taxes that your employer would have paid half of when you were an employee. There's no withholding — you pay it when you file your return, or through quarterly estimated tax payments. One small relief: you can deduct half of the self-employment tax you pay as an above-the-line deduction on your personal return, which slightly reduces the impact.

Because no one is withholding taxes from your business income, you're generally required to make quarterly estimated tax payments to avoid underpayment penalties. The due dates are generally April 15, June 15, September 15, and January 15 of the following year. If you expect to owe $1,000 or more in taxes for the year after subtracting withholding and credits, you should be making estimated payments. A common safe harbor approach is to pay at least 100% of last year's tax liability (or 110% if your prior-year AGI exceeded $150,000) across your four quarterly payments.

Business deductions can significantly reduce your taxable income. Legitimate business expenses — including supplies, equipment, home office costs, business use of your vehicle, software subscriptions, professional development, marketing, and health insurance premiums (for self-employed individuals) — are all deductible against your business income on Schedule C. The qualified business income (QBI) deduction allows most pass-through business owners to deduct an additional 20% of their qualified business income on top of regular deductions, further reducing the effective tax rate on business income.

The entity structure you choose — sole proprietorship, LLC, S corporation, or C corporation — has significant tax implications. A single-member LLC is taxed as a sole proprietorship by default, which is simple but means you owe self-employment tax on all net profits. An S corporation election can allow you to split income between a reasonable salary (subject to payroll taxes) and distributions (not subject to self-employment tax), potentially reducing your payroll tax burden as income grows. However, S corporations come with more administrative overhead and their own rules and restrictions. A tax professional can model out the different structures based on your expected income.

If you have employees, you take on additional obligations: withholding income taxes and the employee's half of Social Security and Medicare taxes, paying the employer's matching half, paying federal and state unemployment taxes, and making regular payroll tax deposits. Missing payroll tax deposits can trigger significant penalties. As a new employer, getting payroll set up correctly — either through payroll software or a payroll service — is one of the most important early steps.