In this inflationary environment, many businesses must raise their prices to continue paying higher wages, taxes, and expenses and at least stay even in terms of profitability. NFIB reports that 70% of small businesses have raised prices, especially in such industries as wholesale, construction, retail trades, and manufacturing. And 46% of owners plan on implementing price hikes (which include some that have already raised prices). When raising prices, businesses primarily focus on how this affects customers…will higher prices discourage sales? But don’t overlook the impact that higher prices have on taxes.
Income taxes
Raising prices may be a wash in terms of profits; more revenue but greater deductions for expenses may cancel each other out. But one of the reasons for raising prices is to increase profits. If price hikes bring in more revenue than the total increase in expenses, it means higher profits. NFIB reported that among owners reporting higher profits, nearly one in five 19%) attributed this to higher prices. When profits increase, expect to pay more in federal (and where applicable, state and local) income taxes.
For owners of pass-through entities, the tax on their share of profits depends on their tax bracket. More profits may 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.
Self-employment tax
For self-employed business owners, greater profits translate into higher net earnings, on which self-employment tax is based. Higher net earnings…higher self-employment tax.
The Social Security portion of self-employment tax, which is 12.4% of 92.35% of net earnings, is capped (net earnings in 2022 of up to $147,000). There’s no cap on the Medicare portion, which is 2.9% of 92.35% of net earnings. Yes, one half of self-employment tax is deductible as a personal deduction of the owner, but the deduction doesn’t wipe out 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 isn’t adjusted annually for inflation: $200,000 for singles and $250,000 for married persons filing jointly.
- Higher net earnings from self-employment may trigger or increase the 0.9% on earned income.
- Owners of sole proprietorships, S corporations, partnerships, and limited liability companies who are merely passive investors and who, as a result of higher prices have greater profits, may have to pay (or pay more) of the net investment income (NII) tax of 3.8% tax on their share of profits (this is a simplification; there’s a formula for figuring the NII tax).
Sales taxes
Sales tax obligations depend not only on what you sell, but where and how much. Five states—Alaska, Delaware, Montana, New Hampshire, and Oregon—have no sales tax. Even where there is a sales tax, some goods and services may be exempt, so sellers don’t have to collect the tax. But most locations require sellers to register, collect sales tax, remit collections to the state, and file returns (typically quarterly). These obligations don’t depend on how much you charge or what revenue is received.
But if you are a remote seller (i.e., you sell online to customers in another state), your sales tax obligations to collect, remit, and report to that other state are triggered if sales exceed a threshold amount. States have different thresholds, but typically this means sales of $100,000 or more. Raising prices may cause a remote seller to cross the threshold. In some states there is an alternative threshold based on the number of transactions (e.g., 200 or more); it’s hard to say whether price increases would impact this alternative threshold.
Conclusion
Raising prices may be desirable or necessary, and tax results may not be a big part of a decision on price hikes. Just be sure to factor in additional taxes and tax responsibilities that may result from higher revenue that is derived from raising prices. Work with your CPA or other tax adviser to know what tax impact any price increases may have on your business and you.
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