How Are Corporations Taxed?
When it comes to taxation, C corporate entities are not taxed the same as other business structures. They face something known as corporate tax, or a levy that is placed on a business’s profit to raise its taxes.
In the United States, the imposed tax on corporations ranges from 15% to a maximum of 35%, making corporate tax the third largest source of revenue for the federal government, after payroll taxes and individual income tax. Figures from the Tax Policy Center estimate that corporate income tax accounted for $343.8 billion in fiscal 2015.
What Qualifies as a Tax-Deductible Expense?
It’s important to understand that because corporations are considered separate legal entities from their owners, they are taxed on all profits that do not qualify as a deductible business expense. Typically, taxable profits include money that is kept within the company to cover retained earnings, as well as profits that are provided to owners and shareholders as dividends.
To reduce taxable profits, corporations are able to deduct many of their business expenses, i.e., money that is spent in the pursuit of profit. This can include:
- Start-up costs
- Operating expenses
- Product and advertising outlays
Additionally, a corporation is able to deduct any salaries and bonuses it pays out, as well as any costs related to employee medical and retirement plans.
Flow-Through Corporations VS C Corporations
However, not all businesses are required to file as a corporation. While C corporations are responsible for paying income tax on profits, “flow-through’ entities like [partnerships], [limited liability companies (LLCs)] and [sole proprietorships] are not required to pay tax on business profits. Most businesses in the United States are taxed as “flow-through” companies.
Rather, in these situations, profits will pass through the business to its owner(s), who are responsible for reporting any income or losses on their individual tax returns.
Although they are taxed differently, flow-through businesses, or [S corporations,] do typically face similar tax rules as corporations when it comes to:
- Any other provisions that affect the measurement of a business’s profits
Are There Advantages to Filing as a Flow-Through Entity?
There are, however, some advantages to being taxed as a flow-through business, rather than a corporation. The primary advantage is that it bypasses the second layer of corporate taxation. This is an issue commonly referred to as double taxation.
Unlike some facets of corporate law, this is a fairly straightforward concept. Corporations have an initial tax on the company’s income. When this net income is dispersed among shareholders, those individuals are also required to pay individual income tax on those dividends. That’s where double taxation comes in.
Additionally, businesses of a flow-through status are also able to deduct a business loss against another source of current income, although they may be subject to limitations for what is known as “passive loss”. This is not possible with corporate entities – C corporation losses are not permitted to be used to offset any income that is earned outside of the corporation.
Benefits of Filing as a Corporation
Advantages to flow-through entities aside, there are also a number of benefits to filing a separate corporate tax return, compared to an additional individual income tax. Some key benefits include:
- A company can deduct health insurance for families, as well as the full cost of fringe benefits like retirement plans and tax-deferred trusts for employees and the business owner(s). Employees and the owner are not taxed on the benefits
- It is easier for corporate entities to deduct losses. A sole proprietor would have to provide evidence that demonstrates the intent to retain a profit before any losses can be deducted
Depending on the size of the corporate entity, it might also be easier to retain profits with a corporate tax return. For example, the initial corporate income tax rate – anywhere from 15% to 25% on the first $75,000 in profits – is lower than most corporate owners’ marginal income tax rate. By paying a corporate tax, an owner can actually retain profits to fund expansion and future growth.
It’s important to note that this rule does not apply to professional corporations because they have a flat tax rate of 35%.
Despite the advantages, reporting a separate corporate tax return can have its drawbacks. For companies that are at risk for experiencing losses, actively involved in investing, or on the brink of a sale, it can actually prove to be a real disadvantage.
Corporate Tax Attorneys
If you have been targeted by the Internal Revenue Service (IRS) or have a dispute regarding your corporate tax return, it is in your best interest to seek the counsel of an attorney specializing in issues of the tax code.
In Dallas and the surrounding communities in Texas, Scammahorn Law Firm, P.C. serves as a leading legal resource for those dealing with tax-related issues, including matters involving corporate taxation.
To discuss your legal options with one of our tax attorneys, call us today at (903) 595-1000 to schedule an initial consultation.