Sole Proprietorships Face Lowest Rates, S Corporations Highest

WASHINGTON, D.C. – The effective federal income tax rate faced by small businesses varies by the legal form of organization, according to a report issued today by the Office of Advocacy of the U.S. Small Business Administration. Average rates range from 13.3 percent for sole proprietorships to 26.9 percent for S corporations. The effective federal income tax rate is the actual amount of taxes paid by a firm as a percent of its net income.

Exceptions to the normal statutory tax rates, such as deductions, exclusions, and credits, have the effect of lowering the tax rates paid by firms. The result is a difference between the statutory rate and the actual or effective rate paid by the business or its owners.

Overall, small businesses of all types pay an estimated average effective tax rate of 19.8 percent. Sole proprietorships face a 13.3 percent rate, small partnerships face 23.6 percent, and small S corporations face 26.9 percent. While not directly comparable, the rate faced by small C corporations is 17.5 percent.

The progressivity of the tax code also affects effective rate calculations, as firms with less income face a lower statutory rate. Nearly 60 percent of small sole proprietorships have a net income of less than $10,000, while only 3.1 percent have a net income of at least $100,000. On the other hand, more than 18 percent of small S corporations have a net income of at least $100,000.

Quantria Strategies wrote Effective Federal Income Tax Rates Faced by Small Businesses in the United States, with funding from the Office of Advocacy. The authors primarily used data from the Internal Revenue Service Individual Statistics of Income Public Use File, 2004, as the basis for the study. For the purpose of this study, the authors define a small business as a firm with less than $10 million in gross receipts.

For more information and a complete copy of the report, visit the Office of Advocacy web site at www.sba.gov/advo.

The Office of Advocacy, the “small business watchdog” of the federal government, examines the role and status of small business in the economy and independently represents the views of small business to federal agencies, Congress, and the President. It is the source for small business statistics presented in user-friendly formats, and it funds research into small business issues.

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The Office of Advocacy of the U.S. Small Business Administration (SBA) is an independent voice for small business within the federal government. The presidentially appointed Chief Counsel for Advocacy advances the views, concerns, and interests of small business before Congress, the White House, federal agencies, federal courts, and state policymakers. For more information, visit www.sba.gov/advo, or call (202) 205-6533.