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Business Taxation: Why Businesses Do Not Pay Income or Payroll Taxes

Updated on March 15, 2019
Dr Jerry Allison profile image

Dr. Jerry Allison is founder of Kairos Advising and Consulting and has worked with businesses and teaching students business for 30+ years.

Governments, federal and state, are constantly looking for revenue. Politicians look to raise taxes but raising taxes on individuals is politically risky. However, since businesses do not vote, businesses become an easy target for taxation. There is also a segment of society that hates business, corporations in particular, and wants to punish these businesses. This punishment often takes the form of taxation. This article focuses on the fact that business does not pay taxes and provides several examples showing why.

Point-By-Point Summary

  1. When faced with income taxes and income tax increases, businesses raise prices to compensate.
  2. When hiring new employees, businesses factor the taxes into the wage amount thereby lowering the employee's wage.
  3. For payroll tax increases after an employee is hired, businesses raise prices to compensate.

Customers and employees ultimately pay the taxes for a business.

Why Businesses Do Not Pay Income Taxes

With regard to income taxes for businesses, profit is a determinate of whether there will be taxes paid or not. If a business has more deductions than there was revenue, then a net loss occurs. The current tax code states that income tax is calculated on profit. If there is no profit, then no tax is paid. In some cases, (notably the subchapter C corporation and sometimes in the subchapter S corporation and limited liability corporation), this loss can be carried forward into subsequent years. So if one of these businesses had a net loss of $100,000, that loss can offset subsequent years’ profits until the loss is used up. This is why sometimes a business might have a profit and not have to pay taxes; a prior year loss offsets the current year profit.

The second case occurs when a business does have profit. There are two possibilities here. First, limited liability corporations and subchapter S corporations are not taxable entities themselves usually; their profit (and loss) flow straight to the individual owners or shareholders. So if a subchapter S corporation has a $100,000 profit, the corporation files an information return and the $100,000 profit is divided up between the shareholders. The shareholders then pay the tax on their individual tax returns. One can then argue that the corporation is still pay taxes, just in a different way. The next paragraphs will clarify that issue.

Limited liability corporations and subchapter S corporations do not pay taxes directly but have profit and loss flow through to the shareholders. The subchapter C corporation does file a tax return and pays the taxes owed on the return. As mentioned above, sometimes losses carried forward offset the profit and sometimes tax credits offset the amount owed which is another reason for a business not paying taxes. However, a simplified example will clearly demonstrate what really happens when corporations expect to pay taxes.

Suppose a business sells the hypothetical widget for $100. In order to make this widget suppose the business pays $80, including all administrative expenses. In this case the business makes $20 profit on which the business would have to pay income taxes. Also, to keep this simple, suppose the corporation pays taxes at a 15% tax rate. So when the corporation files its tax return, it would pay $3 (15% of the $20 profit) to the government. So the business does pay taxes? Wrong. The next paragraph describes what really happens.

Smart business owners plan for taxes. This business owner asks the question, “at what price should the widget be sold to cover expenses, taxes, and make a $20 profit?” Using a little bit of algebra, the business owner will conclude if $20 is to be the profit after taxes, then the profit before taxes should be $23.53*. And since expenses are $80 to create the widget, the final sales price should be $103.53. While for some the numbers might be confusing, the point is simple. The business does not pay the income tax, the customer does when the item is purchased. So what happens if income taxes are raised? The business raises selling prices to compensate for the increased taxes.

Astute business owners, regardless of the legal form, never pay the income taxes themselves; the customers do. This also implies that income tax increases do not hurt businesses; they hurt consumers because the cost of taxation is passing on to them. In the case where someone decides to really punish businesses and take away all the profit, businesses would react by increasing expenses such as payroll or benefits so there is no profit and avoid having the profit confiscated.

Why Businesses Do Not Pay Payroll Taxes

Payroll taxes are divided into two parts: those the employee pays and those the employer pays. Since business taxes are the focus, this article will ignore the employee taxes. The employer is required to pay a portion of the employee’s FICA tax. Currently, the business rate is 7.65% of the gross amount. The employer also must pay unemployment taxes based on the employee’s gross amount. There are federal unemployment taxes and state unemployment taxes. Federal taxes are constant over the entire country, but state unemployment taxes vary greatly by state and business history.

Suppose that a business can afford $20 an hour for an employee. All expenses must fit into the $20. Also assume for the sake of the illustration the employer’s unemployment rate is 2%. So the business will set a wage so that the wage, the FICA taxes, and the unemployment taxes fit within the $20 per hour. Solving another algebraic equation shows the employer will set the wage at $18.24. The employer would pay $18.24 to the employee, $1.40 for FICA, and $0.36 for unemployment.

If it still is not obvious as to who is really paying the payroll taxes, consider this. If the person were hired as an independent contractor where no taxes are taken out and no unemployment taxes need to be paid, the independent contractor would get $20 per hour. However, as an employee the person is only going to get $18.24 per hour with the remainder going to pay the business’ portion of the payroll taxes. It is not the business that pays the payrolls taxes, it is the employee. The business just becomes a conduit to get the money to the government.

Now one might be wondering what happens when there are existing employees and the government raises the FICA tax rate or the unemployment rate. Certainly, the business is not going to lower the employee’s wage to cover the extra taxes. In this case the increase in the tax rates would be handled the same as an income tax increase and the business would increase the sales price of its items. Incidentally, a rise in the minimum wage is handled exactly the same way.

Conclusion On Business Tax Increases

Businesses do not pay taxes; customers and employees pay the taxes instead through increased sales prices and decreased wages. Whenever businesses are attacked by way of tax increases, these businesses respond in one of these ways. There are other ramifications that result from these actions. When prices rise, that is considered inflation. Inflation decreases the buying power of consumers. So when businesses are threatened by increased taxation and those businesses respond by raising prices, then consumers are hurt not only by having to purchase the product at an increased price but the economy can be hurt due to inflation. And inflation has an effect upon many different economic aspects that are outside the scope of this article.

What some people do not realize is that businesses exist to make a profit and businesses will accomplish that goal or shut down. Politicians and others can talk all they want about raising taxes on businesses but the response of businesses will be to raise prices and make the customer pay for the tax. Businesses do not pay taxes.


*The $20 represents 85% of the total profit after taxes have been paid. Thus, dividing $20 by 0.85 will give $23.53. Here is the double check. If $23.53 is the net profit before taxes, then the tax owed will be 15% of $23.53 or $3.53. Subtracting the tax of $3.53 from the $23.35 profit yields a $20 profit after taxes.

** If x is the wage, then the algebraic equation is x + .0765x +.02x = 20. Combining like terms yields 1.0965x = 20 and then x = $18.24.


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