In this inflationary environment, many companies have to raise prices to continue paying higher wages, taxes and expenses and at least stay the same in terms of profitability. NFIB reports that 70% of small businesses have raised prices, especially in sectors such as wholesale, construction, retail and manufacturing. And 46% of owners plan to make price increases (including some who have already raised prices). When raising prices, companies mainly focus on the consequences for customers… Will higher prices discourage sales? But don’t forget the impact that higher prices have on taxes.
Raising prices can be a waste of money in terms of profit; more income but larger deductions for expenses can cancel each other out. But one of the reasons for raising prices is to increase profits. If price increases bring in more revenue than total cost increase, it means higher profits. NFIB reported that of owners reporting higher profits, nearly one in five (19%) attributed it to higher prices. When earnings go up, expect to pay more in federal (and where applicable, state and local) income taxes.
For pass-through entity owners, the tax on their share of profits depends on their tax bracket. More profits can push owners into a higher tax bracket, resulting in a higher tax rate on the portion of taxable income that falls within a higher tax bracket.
For self-employed entrepreneurs, greater profits translate into higher net income, on which the self-employment tax is based. Higher net income…higher self-employment tax.
The Social Security portion of the self-employment tax, which is 12.4% of 92.35% of net income, is capped (net income in 2022 to $147,000). There is no cap on the Medicare portion, which is 2.9% of 92.35% of the net profit. Yes, half of the self-employment tax is deductible as an owner’s personal deduction, but the deduction doesn’t negate the tax increase.
Additional Medicare Taxes
There are two additional Medicare taxes: one based on earned income and another on investment income. Both taxes have a threshold that is not adjusted annually for inflation: $200,000 for singles and $250,000 for married couples filing jointly.Higher net income from self-employment can activate or increase the 0.9% on earned income. Owners of sole proprietorships, S corporations, partnerships and limited liability companies who are purely passive investors and who have greater profits as a result of higher prices may be required to pay (or pay more) of the net income tax (NII) of 3.8 % tax on their share of the profit (this is a simplification; there is a formula for calculating the NII tax).
The VAT obligations depend not only on what you sell, but also on where and how much. Five states – Alaska, Delaware, Montana, New Hampshire and Oregon – have no sales tax. Even if there is a sales tax, some goods and services may be exempt so that sellers do not have to collect the tax. But most locations require sellers to register, collect sales tax, make collections to the state, and file returns (usually quarterly). These obligations do not depend on how much you charge or what income is received.
But if you’re a remote seller (ie you sell online to customers in another state), your VAT obligations to collect, remit, and report to that other state are triggered if the sale exceeds a threshold amount. States have different thresholds, but usually this means a sale of $100,000 or more. Raising prices can cause a remote seller to cross the threshold. In some states, there is an alternate threshold based on the number of transactions (e.g., 200 or more); it is difficult to say whether price increases will affect this alternative threshold.
Raising prices may be desirable or necessary, and tax results may not be a big part of a price hike decision. Just be sure to factor in additional taxes and tax liabilities that may arise from increased income resulting from price increases. Work with your CPA or other tax advisor to understand the tax implications of any price increases for your business and you.
This post How Does Raising Your Company’s Prices Affect Your Taxes? was original published at “https://smallbiztrends.com/2022/05/raising-your-companys-prices.html”