1. Understanding Corporate Tax Liability for C Corporations
2. Double Taxation
3. Special Treatment for Sub-Chapter S Corporations
4. When to Use Form 1120 and Form 1120S
5. Using the Schedule L Worksheet

Corporation tax liabilities for companies vary depending on how businesses are structured. When businesses are structured as corporations, their profits are distributed by paying dividends directly to the owners.

Issuing a dividend doesn't affect corporate tax liability; however, the company's owners will experience some tax ramifications.

Understanding Corporate Tax Liability for C Corporations

For businesses that are structured like traditional corporations (i.e. C corporations), corporate taxes must be paid from their profits. In this case, profit is calculated as the company's total revenue minus expenses.

However, dividends are not business expenses and as such, cannot be deducted from corporate income tax returns. If they were, businesses could effectively eliminate all corporate tax liability by distributing all their profits as dividends. As such, dividends are calculated and distributed from after-tax profits.

Double Taxation

When the company's shareholders receive their dividends, the money must be reported on their individual tax returns. This means that the money paid out as dividends to shareholders is taxed twice.

The first taxation is through the company's overall profit while the second is through the shareholder's income. This double taxation of profits is one of the major disadvantages of structuring businesses as C corporations.

For small businesses that are set up as C corporations, the individuals with the largest shares usually work for the business. In many cases, the stock of such a company is held by one individual, a handful of individuals or a family.

Since the shareholders are on the company's payroll, they are usually compensated with salaries, employee benefits, and bonuses — all of which are legitimate deductible business expenses. This effectively prevents double taxation and lowers the tax liability of the company.

However, the IRS expects the salaries and compensation of shareholders to be commensurate with their position and responsibilities within the company. The IRS constantly looks out for owners who try to eliminate all corporate taxes by assigning all the profits to themselves by way of employee compensation.

Special Treatment for Sub-Chapter S Corporations

Special treatment is allowed for small business corporations, referred to as sub-chapter S corporations. A business that is structured as an S corporation doesn't pay corporate taxes; it can allocate its overall profits to the owners/stockholders who then report it as income on their income tax returns.

The shareholders in S corporations must pay taxes on their allotted share of the company's profits irrespective of whether the business actually distributed said profits to them. For S corporations, the cash distribution of corporate profits (called dividends in C corps) does not affect the tax liability of anyone since the shareholders are already paying taxes on it.

When to Use Form 1120 and Form 1120S

The IRS created Form 1120 for reporting corporate income tax. Form 1120S was creating specifically for reporting income taxes for S corporations.

On Form 1120, corporate representatives are expected to enter the corporation's name, the address of the headquarters, the EIN, the date of incorporation, and its total assets.

Corporate income (i.e. gross profit) is calculated by adding gross returns and sales together, then subtracting the total cost of goods sold. After this, other forms of income such as royalties, rent, interests, etc. are added to get the total income.

Next, the company adds up its total deductions. The IRS lists the following items as deductibles:

  • Advertising.
  • Rent.
  • Repairs.
  • Wages.

Separate forms must be filled out for domestic production activities, depreciation, and officer salaries.

To arrive at taxable income, special deductions, net operating deductions, and total deductions are subtracted from the company's total income.

Using the Schedule L Worksheet

In order to better calculate taxes, corporations can list assets versus liabilities in the Schedule L Worksheet, Inventory, accounts receivable, and cash are all assets while stock, mortgages, and accounts payable are liabilities. The final amount owed by corporations to the IRS is referred to as corporate tax liability.

When starting a business, individuals should consider the various business structures available to them. A business without any official structure is automatically labeled a sole proprietorship. As the owner of a sole proprietorship, you must list all business expenses and income on Schedule C of your income tax return.

This can significantly increase the likelihood of tax audits. Incorporated businesses usually enjoy reduced chances of a tax audit as well as a lower tax liability.

If you need help with corporation tax liabilities for companies, you can post your legal need on the UpCounsel marketplace. UpCounsel accepts only the top 5 percent of lawyers on its site. Lawyers on UpCounsel come from prestigious law schools like Yale Law and Harvard Law and usually have 14 years of legal experience, including work on behalf of or with companies like Airbnb, Menlo Ventures, and Google.