C Corp Tax Rates: Everything You Need to Know
A C corp conducts business, realizes net incomes or losses, distributes profits to its shareholders, and pays taxes.7 min read
2. Personal Holding Company
3. Difference Between S Corporation and C Corporation
4. C Corporation Taxes
5. Qualified Personal Service Corporations
6. C Corps as Separate Taxpayers
7. Corporation Tax Deductions
8. Alternative Minimum Tax (AMT) on Corporations
9. How to Reduce Corporate Income
10. Corporations and Earnings
What Are C Corp Tax Rates?
A C corp conducts business, realizes net incomes or losses, distributes profits to its shareholders, and pays taxes. C corp tax rates can be expensive due to the double taxation that might occur. While C corporations are taxed on profits earned, they can be taxed again on any distributions made to the shareholders in the form of dividends.
However, even after double taxation, their net incomes might be higher than those of sole proprietors and individuals belonging to the top tax brackets. When net income is higher, it is essential for a C corp to plan ahead by accurately estimating business income, personal income, and dividends, and calculating the corresponding tax rates.
When choosing which type of business structure to operate, think about tax rates. While this shouldn't be the only consideration, it's important to know each type of business structure's tax implications.
Personal Holding Company
A personal holding company must pay an additional 20 percent tax on any undistributed personal holding company income. Two tests determine this company's status:
- A stock ownership test, in which five or fewer individuals should own more than 50 percent of the stock value.
- An income test, which requires at least 60 percent of the company's adjusted ordinary gross income for a taxable year to be passive income, such as dividends, interest, royalties, and rents.
A personal holding company can avoid the additional tax by structuring itself as an S corporation.
Difference Between S Corporation and C Corporation
S corporations are pass-through tax entities whereas C corporations are completely separate entities from their owners. In an S corp, corporate income passes through to individual shareholders, who will report their shares of corporate gains or losses, credits, and deductions on their personal tax returns. When choosing a type of business structure, whether it be an S or a C corporation, you'll want to consider both non-tax as well as tax ramifications. The only difference between these two types of corporations is with regard to taxation.
A key difference between businesses that operate as pass-through entities and C corporations is the owners of C corporations are taxed only on the income received from the corporation. Because a corporation is taxable, the profits leftover after being taxed at the corporate level aren't taxed to the owners. Such profits are only taxed when they are distributed to the shareholders as dividends. This would not be the case for unincorporated businesses and S corporations.
Although the opportunity to bypass C corp double taxation can be enticing, it is essential to have a good estimation of future income and tax implications. Each business is unique and needs an elaborate evaluation to determine the most effective legal structure for reducing taxes, limiting liability, and maximizing profits. Besides providing protection for your personal assets and better financing opportunities, a corporation allows you to implement tax scenarios that are unavailable with other forms of business structure.
Also referred to as a regular corporation, a C corporation is taxed as a distinct entity from its owners and shareholders. After the appropriate deductions and credits have been taken into account, the remaining income is the amount taxed on the corporate income tax return. Normal tax rates include certain income-level conditions, in which a corporation is taxed on its level of profits, which varies. The more profits earned, the higher the percentage.
However, if a corporation makes more than 18.3 million, a flat 35 percent is applied. Also taxed at 35 percent are personal service corporations or corporations with employees that spend roughly 95 percent of their time in engineering health, law, accounting, architecture, performing arts, actuarial science, or consulting.
After the profits are taxed, any distributions, also referred to as dividends, made to shareholders are taxed again at the shareholder's tax rates. Therefore, as previously noted, corporations incur double taxation. The advantage to the corporate income tax rates is that corporations need not worry about inflation, as the tax thresholds only change if Congress passes corporate tax legislation.
Another key point is that only income paid as dividends gets taxed twice. Income distributed as salary or deferred compensation is a deduction that the corporation can claim on its income tax return.
Qualified Personal Service Corporations
Certain types of corporations, such as qualified personal service corporations, are not allowed to change their corporate structure to gain more favorable tax rates. While other types of C corps are subject to income-based tax rates and S corps enjoy pass-through taxation, qualified personal service corporations are required to pay a fixed 35 percent rate on all taxable income.
A two-part test, which includes an ownership test and a function test, is conducted to determine qualified personal service corporation status. In the function test, at least 95 percent of all business activities must involve services in fields such as law, health, accounting, engineering, consulting, and others. For the ownership test, existing and retired employees must own all of the corporation's stock.
A corporation that meets these requirements is subject to a 35 percent federal income tax rate, beginning with the first dollar. It is important to know what defines a qualified personal service corporation and assess your company against it. If your corporation qualifies as a personal service corporation, you should distribute all corporate revenue as wages, expenses, and bonuses, with a final income of zero.
C Corps as Separate Taxpayers
A C corp uses Form 1120 to report its earnings and claim its tax credits and deductions. Its income is typically taxed at the corporate level based on the following corporate income tax rates:
- $0 + 15 percent of an amount above $0 for a taxable income above $0 to $50,000.
- $7,500 + 25 percent of an amount above $50,000 for a taxable income above $50,000 to $75,000.
- $13,750 + 34 percent of an amount above $75,000 for a taxable income above $75,000 to $100,000.
- $22,250 + 39 percent of an amount above $100,000 for a taxable income above $100,000 to $335,000.
- $113,900 + 34 percent of an amount above $335,000 for a taxable income above $335,000 to $10,000,000.
- $3,400,000 + 35 percent of an amount above $10,000,000 for a taxable income above $10,000,000 to $15,000,000.
- $5,150,000 + 38 percent of an amount above $15,000,000 for a taxable income above $15,000,000 to $18,333,333.
- 35 percent of an amount above $18,333,333 for a taxable income above $18,333,333.
Effective tax planning can help reduce the effect of double taxation while allowing you to take advantage of the corporate structure to gain other benefits. With its top corporate tax rate now lower than the top individual rate and its ability to retain income instead of passing all its earnings through to its shareholders, a C corp might be more tax-advantaged than other business structures in certain situations.
Corporation Tax Deductions
A corporation can also deduct all necessary and ordinary business expenses. Deductible expenses include:
- Startup expenses
- Operating expenses
- Advertising campaign expenses
- Tuition reimbursement
- All costs of medical and retirement plans for employees
- Travel expenses
- Interest payments
- Fuel and excise taxes
- Legal fees
- Tax fees
The corporation can deduct any expense that relates back to the business itself.
Alternative Minimum Tax (AMT) on Corporations
Corporations that have benefited from too many tax preference items might be subject to AMT. The AMT rate is generally 20 percent, but it gets reduced to 15 percent for certain items. It is usually much easier for small corporations to avoid AMT than high-net-worth individuals.
How to Reduce Corporate Income
Owners of sole proprietorships, partnerships, and LLCs must pay taxes on all business profits on their individual income tax returns, whether or not profits are taken out of the business. However, in a corporation, the Internal Revenue Service (IRS) allows corporations to leave profits in the business up to a certain limit, generally $250,000, without incurring additional tax penalties. In some circumstances, owner salaries can offset the corporation's full net profit, so corporate income tax isn't due.
However, as noted above, a corporation that pays its shareholders dividends is vulnerable to corporate income tax on such distributions. When incurring this tax, the rate at which such dividend payments will be taxed is at the capital gains rate and not the individual's highest marginal tax rate, which is income-based. Therefore, because the capital gains rate is likely to be much lower, the amount of tax owed will be less.
Lastly, the dividends received by a shareholder who participates actively in the business's operations are not prone to two taxes usually imposed on those with higher incomes:
- The 0.9 percent Medicare surtax on income.
- The 3.8 percent tax on net investment earnings.
While you might choose not to distribute dividends to the shareholders in an effort to save on taxes, the IRS will likely assume, if you are a profitable business, that some or all of those owners' salaries are dividends being disguised as salary, thus resulting in tax penalties. To avoid such penalties, make sure all employees, including owners, receive reasonable salaries. While all salaries are considered deferred compensation and, thus, deducted from corporate income taxes, any unusually high salaries might be looked into by the IRS. The IRS could conclude that a portion of this salary is a disguised dividend.
You can avoid this by paying out some dividends every year and making sure owner salaries aren't considerably higher than the industry average. It is critical to have proper corporate documentation in the event the IRS challenges the payments. Make sure your corporate record book has resolutions authorizing all salaries and dividends.
Corporations and Earnings
A major difference between C corporations and businesses that operate as pass-through entities is that the owners of C corporations are only taxed on the income they receive from the corporation.
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