How Do Corporations Not Pay Taxes
A common question from business owners is "how do corporations not pay taxes?" Corporations are separate legal entities from their owners.3 min read updated on February 01, 2023
A common question from business owners is "how do corporations not pay taxes?" Corporations are separate legal entities from their owners, and therefore the company itself is charged a tax on all its profits that cannot be deducted as business expenses. This means a large portion of the corporation's income can potentially be taxable by law.
Corporations are treated differently than many other business structures when it comes to taxes. Rather than paying taxes on business profits, the other business entity types are able to pass profits onto the owners of the businesses, who are then responsible for paying taxes on their own personal tax returns.
What Are Taxable Profits?
Typically, taxable profits consist of the company's profits and retained earnings kept by the company to pay for business expenses or expansion of the company. The profits also include dividends that are paid to the owners and shareholders of the company.
How to Reduce Taxable Profits
One way to reduce the amount of taxable profits, and ultimately the amount of taxes paid, is for the corporation to deduct business expenses. Some of the business expenses that fall under this category include:
- Startup costs
- Operating expenses
- Product costs
- Advertising expenses
- Employee salaries
- Employee profits
- Employee medical costs paid by the company
- Employee retirement plan costs paid by the company
The corporation will only owe taxes remaining on the profits after all of the expenses for the business have been accounted for and deducted from the profits.
How Corporations Are Taxed
When a corporation has after-tax profits, there are typically two options for how to spend them. The first option is to return the profits to their shareholders, who are the owners of the corporation, including all the people who hold company stock. The second option is to keep the profits, turn them into retained earnings, and reinvest the money into the business to facilitate growth. The latter option is also worthwhile for the shareholders, as the investment will help grow the business and ultimately increase the price of the company stock.
It's important to note that the profits used in these two options are after-tax. The company must first pay taxes on the profits before investing the profits back into the company or paying them to the shareholders as dividends. This can be problematic, as it greatly reduces the amount of profits that the company retains.
How to Pay Corporate Taxes
When filing taxes for a corporation, the taxes are paid at the corporate income tax rate. The United States corporate tax rate is among the highest in the world, topping out at 35 percent. The countries that come close to the same tax rate include France and Belgium. However, even at the high corporate tax rate, many United States corporations pay far less than 35 percent of their profits.
Recent studies show that the average company paid only about 18 percent in taxes. This is partly due to loopholes and companies becoming extremely savvy in tax practices. Some corporations have become quite crafty at finding ways to reduce their owed taxes. These companies have found ways to boost equipment expenses by accelerating the depreciation of their equipment. Another tactic is to use overseas operations to show increased expenses. Some corporations even incorporate outside of the United States where the corporate tax rate is much lower. A corporation may also attempt to reduce taxes by utilizing various corporate tax breaks within certain industries.
Another frequently used strategy is to hold the cash that has been earned in internal business practices. If the company were to bring these profits back into the United States, they would be forced to pay taxes on them. Utilizing overseas subsidiaries has proved to be a key way for some large technology companies to avoid paying taxes on a large portion of their sales and profits.
How to File Corporate Taxes
The corporation should use an IRS Form 1120 to file taxes. Any taxes owed by the corporation should be estimated for the year and should make payments to the IRS each quarter. This is done in April, June, September, and January.
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