Tax payments are a deductible business expense in most cases, but not all. Federal income taxes and IRS penalties are never deductible, no matter how your business is structured. Almost everything else a business pays to a taxing authority — employer payroll taxes, property taxes on business assets, state and local income taxes at the entity level, sales tax built into supply purchases, excise taxes, and half of self-employment tax — reduces your taxable income when the payment is ordinary and necessary to the trade or business. The rules turn on the type of tax, your entity type, and who the payment goes to.
Taxes You Cannot Deduct
Federal income tax is the one payment nearly every business owner makes that never reduces taxable income. IRC Section 275 flatly prohibits the deduction, and the prohibition reaches every entity type: sole proprietorships, partnerships, S corporations, and C corporations.1Office of the Law Revision Counsel. 26 USC 275 – Certain Taxes Quarterly estimated payments, year-end balances due, and corporate income tax paid under a company’s own EIN all sit outside the deduction rules.
IRS penalties are also off the table, but under a different rule. A separate provision bars deductions for fines and penalties paid to a government, and that covers the failure-to-pay penalty (0.5% of unpaid balance per month, up to 25%), accuracy-related penalties, and estimated tax penalties.2Office of the Law Revision Counsel. 26 USC 6651 – Failure to File Tax Return or to Pay Tax
Interest on federal tax underpayments is the closer call. IRC Section 163 generally allows a deduction for interest on indebtedness, and for a C corporation, interest on a federal tax deficiency can qualify as deductible business interest. Sole proprietors and other individual filers usually cannot deduct this interest because it is treated as nondeductible personal interest.
State and Local Income Taxes
IRC Section 164 allows deductions for state and local income taxes paid in carrying on a trade or business, but the mechanics vary sharply by entity type.3Office of the Law Revision Counsel. 26 USC 164 – Taxes
C Corporations
C corporations get the cleanest result. A C corporation deducts state and local income taxes as a direct business expense on its federal return, with no cap. If the corporation pays $200,000 in state income tax, the full $200,000 reduces federal taxable income.
Sole Proprietors and Pass-Through Owners
If you operate as a sole proprietor, partner, or S corporation shareholder, business income passes through to your individual return. State and local income taxes on that income generally land on Schedule A as an itemized deduction, not on Schedule C or the entity return. That distinction pulls them under the individual SALT cap.
Under current law, the SALT deduction cap is $40,000 for most filers, or $20,000 if married filing separately. The cap covers combined state and local income taxes, sales taxes, and property taxes on the individual return.4Internal Revenue Service. Topic No. 503, Deductible Taxes The cap begins phasing down once modified adjusted gross income exceeds $505,000, and fully phased-down taxpayers are limited to $10,000.
The Pass-Through Entity Tax Election
More than 30 states now offer an entity-level tax election that lets partnerships and S corporations pay state income taxes directly at the entity level rather than passing them through to owners. The IRS blessed this treatment in Notice 2020-75, confirming that these entity-level payments are deductible on the partnership or S corporation federal return when computing non-separately stated income.5Internal Revenue Service. Notice 2020-75 – Deductibility of Payments by Partnerships and S Corporations for State and Local Income Taxes Because the deduction happens at the entity level, it bypasses the individual SALT cap.
Self-Employment Tax
Self-employed individuals pay both the employer and employee portions of Social Security and Medicare taxes, a combined 15.3% on net earnings. Half of that is deductible. IRC Section 164(f) allows an above-the-line deduction equal to 50% of the self-employment taxes imposed under Section 1401.6Office of the Law Revision Counsel. 26 US Code 164 – Taxes The deduction goes on Schedule 1 of Form 1040, so you get it whether or not you itemize.
Section 275 includes an explicit carve-out for this deduction, stating that its prohibition on deducting federal taxes does not apply to taxes deductible under Section 164(f).1Office of the Law Revision Counsel. 26 USC 275 – Certain Taxes You compute the amount on Schedule SE and carry it to Schedule 1, line 15.7Internal Revenue Service. 2026 Schedule SE (Form 1040) – Self-Employment Tax
Payroll and Employment Taxes
If you have employees, the taxes you pay as the employer are fully deductible. For most businesses with staff, this is the largest deductible tax category.
Employer FICA
The employer share of Social Security tax is 6.2% on wages up to $184,500 in 2026. The employer share of Medicare tax is 1.45% on all wages, with no cap.8Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates Both are deductible. A business paying $500,000 in total wages owes roughly $38,250 in employer FICA, and every dollar reduces taxable income.
Federal and State Unemployment Taxes
Federal Unemployment Tax (FUTA) applies at 6.0% on the first $7,000 of wages per employee. Employers who pay state unemployment taxes on time receive a credit of up to 5.4%, dropping the effective FUTA rate to 0.6%, or a maximum of $42 per employee per year.9Employment and Training Administration. Unemployment Insurance Tax Topic State unemployment tax rates and wage bases vary, and the state payments are also deductible.
Don’t Double-Count Employee Withholding
A common mistake is trying to deduct the federal income tax and FICA amounts withheld from employee paychecks. Those amounts are already included in the gross wages you deduct as a labor expense. Claiming them again as a tax expense counts the same dollars twice. You deduct the full gross wage, and the withholding is simply how part of that wage gets routed to the IRS on the employee’s behalf.
Business Property Taxes
State and local taxes on real property and personal property used in your business are deductible under IRC Section 164. This covers real estate taxes on office buildings, warehouses, and retail locations, and personal property taxes on business equipment such as vehicles, machinery, and computers.3Office of the Law Revision Counsel. 26 USC 164 – Taxes
When property serves both personal and business purposes, only the business portion of the tax is deductible. If 20% of your home is a dedicated office, you deduct 20% of the property taxes. The IRS generally calculates this using the square footage of the business area relative to the total home area.10Internal Revenue Service. Publication 587 – Business Use of Your Home The same proration applies to a vehicle used partly for business.
Taxes paid in connection with acquiring property work differently. Transfer taxes or prorated property taxes assumed at closing get folded into the property’s cost basis rather than deducted currently, and you recover them through depreciation.11Internal Revenue Service. Publication 551 – Basis of Assets
Sales and Excise Taxes
Sales tax treatment depends on what you bought. Sales tax paid on a capital asset — a delivery truck, manufacturing equipment, a commercial oven — gets added to the cost basis of the asset and recovered through depreciation. IRC Section 164 requires this treatment for taxes paid in connection with acquiring property.3Office of the Law Revision Counsel. 26 USC 164 – Taxes So a $30,000 delivery truck with $2,100 in sales tax has a depreciable basis of $32,100.
Sales tax on everyday supplies and consumables like printer paper, cleaning products, or postage is simply part of the purchase price and deducted immediately as an ordinary business expense. There’s no need to break out the tax separately.
Federal excise taxes on fuel, heavy highway vehicle use, and certain environmental activities are deductible as ordinary business expenses in the year paid.12Internal Revenue Service. Income and Expenses 6 The heavy vehicle use tax applies annually to highway vehicles with a taxable gross weight of 55,000 pounds or more, and that payment is fully deductible.13Internal Revenue Service. Excise Tax
Foreign Income Taxes
A business that pays foreign income taxes chooses each year between claiming a dollar-for-dollar tax credit on Form 1116 or deducting those taxes as a business expense. You cannot do both in the same year. If you take the credit, you take it for all qualifying foreign taxes, and the same all-or-nothing rule governs the deduction.14Internal Revenue Service. Foreign Tax Credit – Choosing to Take Credit or Deduction
The credit usually beats the deduction. A credit reduces tax dollar for dollar; a deduction only reduces the income subject to tax. The deduction can win in narrow situations, such as when foreign tax credit limitations would leave part of the credit unusable. If you take the deduction, you don’t need to file Form 1116.15Internal Revenue Service. Instructions for Form 1116
Tax Preparation and Related Professional Fees
The cost of preparing your business tax return is a deductible business expense under the general rule for ordinary and necessary business expenses. This covers CPA and accountant fees for preparing Schedule C, a partnership return, or a corporate return, plus tax software used for business filings and e-filing fees. If an invoice covers both business and personal returns, only the business portion qualifies.
Legal fees for business tax matters — audit representation, tax planning, resolving a business-related IRS dispute — follow the same rule and are deducted on the business return in the year you pay them. Individual W-2 employees lost the ability to deduct tax preparation fees as a miscellaneous itemized deduction after 2017, and that suspension remains in effect through at least 2025. Business owners face no such restriction.