Navigating federal and state business taxes can feel overwhelming for small business owners. Each level of government has different rules, rates, and deadlines that directly impact your bottom line. By understanding these differences, you can make smart financial planning decisions that can save you thousands of dollars.
A strategic approach to business tax planning helps you maximize deductions, minimize taxable income, and stay compliant with all tax laws. In this guide, you’ll learn everything you need to know about federal and state tax obligations for businesses and how to manage both effectively.
3 types of federal business taxes
The federal government collects a variety of taxes from businesses operating in the United States. The Internal Revenue Service (IRS) administers these taxes to fund essential government services and tracks tax obligations to ensure all businesses contribute their fair share to federal revenue.
Here are the three primary types of taxes the federal government collects from businesses (and sometimes the business owners themselves):
1. Federal business income tax
Businesses incorporated as C corporations are obligated to pay federal business income tax. At the flat rate of 21%, it represents the most significant tax obligation for most businesses. This income tax applies to the business’s net income. Net income is the result of deducting business expenses from gross income—or all the money your business generates.
Pass-through entities like limited liability companies (LLCs), S corporations, partnerships, and sole proprietorships are not subject to business income tax at the federal level. Instead, the owners report the business’s income on their personal income tax returns and pay tax on those profits at their individual income tax rate, which as of 2025 ranges from 10% to 37%.
2. Payroll taxes
Federal payroll taxes apply to businesses with employees. They include a variety of taxes that go toward funding national benefit programs. Here are the tax rates for the three federal payroll taxes in 2025:
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Social security tax. Takes 6.2% from both the employer and employee (12.4% total) on wages up to $176,100 in 2025.
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Medicare taxes. Takes 1.45% from both parties (2.9% total) with no wage limit, plus an additional 0.9% Medicare tax on earnings over $200,000 for single filers, $250,000 for married couples filing jointly, and $125,000 for married couples filing separately.
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Federal unemployment tax (FUTA). Takes 6% on the first $7,000 of each employee’s annual wages. However, if the company also pays state unemployment tax, there’s a tax credit available for up to 5.4%.
3. Self-employment tax
Owners of sole proprietorships, partnerships, or LLCs taxed as either of those entity types are considered self-employed and subject to self-employment tax. In 2025, the federal tax rate is 15.3% on earned income of $400 or more. This tax ensures that individuals who work for themselves contribute to the benefit programs funded by payroll taxes, just like traditional employees. The 15.3% breaks down into 12.4% for Social Security contributions and 2.9% for Medicare taxes.
Self-employed individuals can claim a tax deduction for half of their self-employment tax payment. This effectively reduces their federal taxable income and overall federal income tax liability. The deduction helps offset the burden of paying both the employer and employee portions of Social Security and Medicare taxes.
4 types of state business taxes
- State corporate income tax
- State unemployment tax
- State entity-specific taxes
- County and municipal business taxes
While federal business tax laws are consistent nationally, state taxes create a complex web of obligations that differ significantly between jurisdictions. Here are the four main categories of state and local taxes businesses face:
1. State corporate income tax
Like the federal government, most states impose a flat corporate income tax on C corps; but some impose marginal rates based on earnings, and others collect no tax on corporate income. These rates vary widely, ranging from North Carolina’s 2.25% flat rate (the lowest) to New Jersey’s 11.5% marginal rate (the highest). South Dakota and Wyoming impose no corporate income tax at all.
2. State unemployment tax
State unemployment tax serves a similar function to federal unemployment tax—funding state unemployment insurance programs through proportions of employees’ earnings that employers must pay. Like state corporate income tax, rates for state unemployment taxes vary widely by jurisdiction. For example, Connecticut employers pay marginal unemployment tax rates between 1.1% and 8.9% on employee earnings above $26,100, while Idaho employers pay marginal rates between 1% and 5.4% on employee earnings above $55,300.
3. State entity-specific taxes
Many states impose taxes on specific entity types. Some don’t recognize certain entity types that are recognized by the IRS—essentially reclassifying them as other entities strictly for tax purposes.
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LLCs. Some states impose annual taxes on locally formed LLCs. For example, California charges an LLC tax of $800, and Delaware charges a $300 tax.
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S corporations. While S corps enjoy pass-through status under federal income tax law, some states don’t recognize S corp elections and require those companies to pay corporate income taxes at the state level while maintaining pass-through treatment federally. The District of Columbia, New Hampshire, and Tennessee don’t recognize federal S corp elections for state tax purposes. Even some municipalities, like New York City, don’t recognize the entity for tax purposes—meaning S corps in New York City must pay corporate taxes at the municipal level, even if they avoid them at the federal level. Some states that do recognize S corps for tax purposes nevertheless apply a special tax to the entity type—like California’s 1.5% tax on any S corp that sources income from the state.
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Partnerships. Some states impose entity-level taxes on partnerships despite their pass-through treatment under federal law. For example, Alabama imposes business taxes on partnerships with more than 50 partners.
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Pass-through entity tax (PTET). States that offer a PTET allow pass-through entities like LLCs, S corps, and partnerships to pay state income tax at the entity level rather than having owners pay individually. Qualifying businesses may elect to be taxed under PTET because it allows the business to deduct the full amount of state business income tax paid at the entity level on their federal tax returns. This effectively lets them bypass the $10,000 cap on the state and local taxes that owners can deduct from their personal federal income taxes, known as the SALT deduction. More than 30 states have enacted legislation that creates a PTET.
4. County and municipal business taxes
Within states, county and municipal authorities can also impose taxes on businesses operating within their boundaries. For example, New York City imposes a corporate tax on businesses that earn more than $1,128,000 in gross receipts from activity in the city.
Federal vs. state taxes: What’s the difference
Many new business owners are surprised by how much state and federal taxes differ in both scope and application—from basic rates to when payments are due. Understanding how federal income taxes differ from state taxes can help businesses and their owners gain a clearer picture of their tax obligations and ensure ongoing compliance with both state and federal tax laws.
Tax rates
At the federal level, businesses are taxed in one of two ways, depending on entity type. C corps are subject to corporate income taxes at a flat tax rate of 21%. For LLCs, S corps, partnerships, and sole proprietorships, business earnings are passed through to owners, who are then taxed based on their personal income tax rates.
State corporate income tax rates differ by jurisdiction. Some states apply flat tax systems, while others apply marginal tax rates. New Mexico, for example, imposes a flat 5.9% corporate income tax rate, while Hawaii applies marginal rates ranging from 4.4% to 6.4%. States largely treat pass-through entities similarly to the federal government for tax purposes—however, not all states recognize S corps as pass-through entities for state tax purposes.
Deductions
The federal tax code provides numerous tax deductions for ordinary and necessary business expenses. According to the IRS, “ordinary and necessary” expenses are those that are common and accepted in a business’s trade, and are helpful and appropriate for the operation of that business. Examples include:
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Advertising and marketing costs
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Utilities for a warehouse or store
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Office supplies
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Equipment
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Wages and salaries paid to employees
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Contributions to employee retirement plans
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Lease payments
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State and local taxes
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Business insurance
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Professional services (lawyers, accountants, etc.)
These deductions reduce taxable income and can generate tax refund opportunities when properly utilized. However, state taxes may not allow certain federal deductions, or may require modifications to federal taxable income. For example, the Qualified Business Income (QBI) deduction, which allows self-employed individuals and small business owners to potentially deduct up to 20% of their qualified business income, is not available at the state level.
Similarly, some state-level deductions are not recognized by federal tax authorities. For example, some states offer deductions for general casualty or theft losses—like a stolen company car, or a shop burning down. But federal tax authorities only recognize a casualty loss deduction resulting from federally declared disasters, like a hurricane or wildfire.
Payment schedules
The federal tax payment schedule follows standardized rules under the tax code. Estimated quarterly payments are due throughout the year (April 15, June 15, September 15, and January 15 of the following year), with annual federal tax returns filed by April 15 for most businesses. State and local payment schedules often mirror federal deadlines, but can vary. This is especially true for extensions—up to October 15 for returns in California, for example.
Federal and state tax example
Here’s a practical example of how federal and state business taxes work together. Marc operates a successful single-member LLC taxed as a sole proprietorship, selling outdoor sporting and camping gear online, with $200,000 in annual net income. His business is headquartered in California, but he sells nationwide.
Federal income tax example
Marc’s $200,000 business profit passes through to his personal income tax return and he pays federal income tax on it via the progressive income tax system. His federal taxable income calculation includes:
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Gross income: Total sales revenue of $350,000.
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Cost of goods sold (COGS): $105,000
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Business deductions: $45,000
His major business deductions include:
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Home office expenses: $8,400 (700 square feet of dedicated workspace)
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Inventory storage and fulfillment costs: $18,000
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Business vehicle expenses: $4,200 (6,000 miles at 70¢/mile)
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Marketing and advertising costs: $8,500
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Professional services (e.g., accounting, legal): $3,600
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Business insurance: $2,300
This results in a taxable net income of $200,000.
Additionally, Marc will owe self-employment taxes of $28,284 (15.3% of his net income of $200,000). However, he can claim a tax deduction for half of this amount, or $14,142, against his federal income tax liability.
State income tax example
At the state level, since Marc’s business is located in California, he must pay the state’s state income tax in addition to his federal tax burden. California imposes a progressive income tax system with rates ranging from 1% to 12.3% on personal income tax returns.
Marc will be subject to additional state and local taxes, including:
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California’s S corp tax, if he elects to have his LLC taxed as one
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California’s franchise tax of $800 annually
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California state and local sales taxes
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Economic nexus requirements triggering sales tax collection duties in at least 20 states
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Local business taxes varying by city and county within California
Federal vs. state business taxes FAQ
What state pays the least taxes?
States with no personal income tax include Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. For corporate income taxes, North Carolina has the lowest rate at just 2.25%. New Hampshire applies an interest and dividends tax only, but it doesn’t tax other business income. However, states that don’t apply income tax or impose low corporate taxes often make up for this lost tax revenue elsewhere—with sales tax, property taxes, and excise taxes, for example.
What is the difference between federal and state taxes?
Federal taxes fund national programs like Social Security, Medicare, defense, and federal services, while state taxes support local infrastructure, education, and state-specific services. Federal tax rates remain consistent nationwide, but state tax rates differ significantly by location. The IRS administers federal tax laws, while local governments and state agencies handle state and local tax collection.
Can businesses get a federal tax refund?
Yes, businesses can receive federal tax refunds when their taxes paid and credits exceed their actual tax liabilities. This commonly occurs when businesses overpay estimated quarterly payments, claim refundable credits, or experience lower-than-expected taxable income.
