How Are Corporations Taxed: Everything You Need to Know
Since a corporation stands as a separate legal entity from its owners, the business itself must pay its own taxes based on the company’s profits. 6 min read
How Are Corporations Taxed?
How corporations are taxed is based on business profits. Other business structures, however, operate differently. For example, for those entities operating as a partnership or limited liability company (LLC), business taxes are reported on the income and losses on the partners’ personal tax returns. Since a corporation stands as a separate legal entity from its owners, the business itself must pay its own taxes based on the company’s profits.
Corporation Tax: An Overview
Corporate tax rules in the U.S. are the same for all US-based corporations and no different for multi-national corporations that are based in the U.S. However, some US businesses are taxed as flow-through entities, including sole proprietorships, partnerships, and eligible S corporations; and therefore, are not subject to the corporate income tax. However, such owners of these types of flow-through entities must include the allocated share of business profits in their own individual income tax return. Corporations, however, can incur double taxation, on both the corporation’s tax return and on the shareholder’s individual tax return.
Taxes on profits range from 15-35 percent on corporations in the United States. The corporations’ taxable profit can be calculated by subtracting the allowed deductions from the corporation’s receipts. The deductions generally include the costs of goods sold, wages for employees, and other business-related expenses.
For residential multi-national companies, taxes are paid on the worldwide profits; however, tax on the profits of the direct foreign subsidiaries is deferred. These types of entities can also claim a tax credit for taxes paid to foreign governments so long as the amount is not greater than the company’s U.S. tax liabilities.
At the shareholder level, a second layer of taxation can be established against such shareholders based on capital gains from selling shares. The current maximum tax rate on both dividends and capitals gains is 23.8 percent, which already includes 3.8% tax on net invested income.
Corporation Tax Requirements
- If a corporation owes taxes, it must make an effort to estimate the amount of tax that will come due and subsequently make quarterly payments to the IRS in April, June, September, and January.
- U.S. corporate tax returns are generally due on March 15; however, it can request a six-month extension thereby making taxes due in September of that year.
- If a corporation has over $10 million in assets, it is required to file online.
Difference Between S Corporation and C Corporation Taxation
S corporations are pass-through tax entities whereas C corporations are completely separate entities from its owners. When choosing which type of business structure, whether it be an S or C corporation, you’ll want to consider both non-tax as well as tax ramifications. However, keep in mind that the only difference between these two types of corporations is with regard to taxation. In terms of business laws, compliance requirements, and asset protection purposes, and S and C corporation are treated the same.
While you shouldn’t solely consider the tax benefits or consequences when choosing which type, you should certainly remember the tax benefits and drawbacks associated with each one.
When considering whether to incorporate as an S or C corporation, you’ll want to first consider the typical non-tax related issues, including:
- The simplicity of receiving capital
- The capacity to develop your business
- Consistent planning
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 that they receive from the corporation. Since a corporation is taxable, the profits leftover after being taxed at the corporate level are not taxed to the owners. Such profits are only taxed when they are distributed to the shareholders as dividends. However, this would be the case for unincorporated businesses and S corporations.
C Corporation Taxes
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 the following income-level conditions:
- Between $0-$50,000: 15 percent
- Between $50,000-$75,000: $7,500 + 25 percent on the amount > $50,000
- Between $75,000-$100,000: $13,750 + 34 percent on the amount > $75,000
- Between $100,000-$335,000: $22,250 + 39 percent on the amount > $100,000
- Between $335,000-$10 million: $113,900 + 34 percent on the amount > $335,000
- Between $10 million-$15 million: $3,400,000 + 35 percent on the amount > $10,000,000
- Between $15 million-$18.3 million: $5,150,000 + 38 percent on the amount > $15,000,000
- Over 18.3 million: 35 percent
Corporations with employees that spend roughly 95 percent of the time in the areas of engineering, law, health, accounting, architecture, actuarial science, consulting, or performing arts are taxed a fixed rate of 35 percent of net profits.
After the profits are taxed using the above chart, 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 corporate tax legislation is passed by Congress.
Another key point to keep in mind is that only income paid as dividends are taxed twice. Income distributed as salary or even deferred compensation is a deduction that the corporation can claim on its income tax return.
Corporation Tax Deductions
To further note the deductions that a corporation can take, all necessary and ordinary business expenses can, in fact, be deducted. Therefore, any start-up expenses, operating expenses, and advertising campaign expenses can be deducted. Salaries, bonuses, and tuition reimbursement that the corporation pays as well as any and all costs of medical and retirement plans for employees can also be deducted. Even insurance premiums, travel expenses, interest payments, fuel and excise taxes, legal fees, tax fees, and bookkeeping can be deducted. Essentially any expense that the corporation can relate back to the business itself can be deducted.
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 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, salaries to the owners can offset the complete net profit of the corporation, so that there isn’t any corporate income tax due.
However, as noted above, a corporation that pays dividends to its shareholders is subject to corporate income tax on such distributions. However, 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 maximum marginal tax rate, which is income-based. Therefore, since the capital gains rate is likely to be much lower, the amount of tax to be owed will be less.
Lastly, the dividends rewarded to shareholders that actively contribute in the operations of the business are not subject to the 0.9 percent Medicare surtax on earnings or the 3.8 percent tax placed upon net investment income that are usually imposed on those with higher incomes.
While you may 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 the salaries of those owners are actually dividends being disguised as salary, thus resulting in tax penalties. In order to avoid such penalties, you’ll want to ensure that all employees, including those that own the corporation, receive reasonable salaries. While all salaries are considered deferred compensation and thus deducted from corporate income taxes, any unusually high salaries (those that are just so high and raises a red flag) may be looked into by the IRS, in which it could conclude that a portion of the salary is a disguised dividend.
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 that they receive from the corporation.
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