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How Do Corporate Income Taxes Work?

January 14, 2022

Unique from any other business structure, corporations are the only type responsible for paying their own income taxes.

With this being true, how does it work, and how do business owners ever profit from structuring as a corporation?

To answer these, you must first understand the different types of corporations and their tax structure.

C-Corporation vs. S-Corporation

A C-Corporation is what most people think of when they think of a typical, big corporation.

It’s the type of corporation you receive when you initially form it without supplying additional documents.

On the other hand, business owners can file an election with the IRS after forming their corporation to classify as an S-Corporation.

The deadline to file an election with the IRS is two months and 15 days after forming the company, or the beginning of the tax year in which you wish to elect S-Corporation status.

Companies with fewer than 100 shareholders and one class of stock are more likely to choose S-Corporation status.

In short, A C-Corporation would be your larger corporation, whereas an S-Corporation would be your smaller, less-developed corporation, pending the owner elected for that status.

C-Corporation Taxes

C-Corporations are taxed based on their profits, just like individuals.

After deducting business expenses and paying out any owed money to shareholders, they must report any profit they earn.

Additionally, they can deduct any business expenses on their tax return, including employee salaries, employee benefits, supplies, advertising, operations, etc.

Before calculating their corporate tax, a business owner must deduct these expenses. Estimated taxes get filed quarterly based on these expenditures.

Corporations are responsible for filing IRS Form 1120 and paying the corporate income tax rate on any profits.

If the corporation owes taxes, it must estimate the total amount due and make quarterly payments, due no later than the 15th day of the 4th, 6th, 9th, and 12th months of their tax year.

To make matters simple, if you follow the calendar year for your tax year, your tax payments would be due on the 15th day of April, June, September, and December.

Double Taxation

One of business owners’ most common complaints about the C-Corporation structure is the double taxation on profits.

As the owner, you pay taxes on the net profits and then distribute dividends to the shareholders, who also must pay income taxes on this amount again.

The smaller C-Corporations avoid double taxation by not paying dividends to shareholders and paying them tax-deductible salaries and bonuses instead.

Corporation Tax Rates

C-Corporations get taxed on income earned worldwide, not just income earned in the United States.

At the federal level, tax rates for C-Corporations were up to 35%, and state and local taxes increased the marginal tax rate to up to 39% before the Tax Cuts and Jobs Act (TCJA) passed in 2017.

However, the tax rate for most U.S. C-Corporations ranged from 12% to 28%.

Signed into law in December of 2017, the TCJA significantly lowered the corporate income tax rate to 21%.

Because a graduated scale previously determined tax rate, some large corporations now had lower taxes to pay, while others with smaller revenues had higher taxes to pay.

Retained Earnings

Retained earnings are any taxable profits kept in the company at the end of the year to cover the expenses or expansion of the company.

By keeping some of the profits in the company at the end of the year, business owners can secure a lower tax rate on those profits.

However, this does not apply to professional corporations since they get taxed at a flat tax rate of 35%.

Additionally, there is a limit to how much of your profits you can keep within the company. The IRS will allow you to keep a total of $250,000 at any given time without facing any tax penalties.

Professional corporations may face a different limit, not being able to retain more than $150,000 at one time.

S-Corporation Taxes

S-Corporations are taxed differently from C-Corporations. Instead, they get taxed like partnerships and many LLCs.

Rather than being double taxed, profits and losses pass through to the individual owners. They are then taxed on their personal income taxes rather than at the entity level.

Since S-Corporations are typically smaller than C-Corporations and their income is not taxed at the entity level, owners secure tax savings.

To file taxes for your S-Corporation, you will submit IRS Form 1120-S.

Tax Cuts and Jobs Act

In addition to the flat 21% tax rate for the corporate income tax rate, the Tax Cuts and Jobs Act established a new income deduction for pass-through entities.

Owners of sole proprietorships, LLCs, and S-Corporations, from 2018 through 2025, can deduct up to 20% of the net income from the entity for income tax purposes.

Unfortunately, C-Corporations do not benefit from this deduction since they are not pass-through entities.

Like any other business structure, there are advantages and disadvantages to both corporate tax filing options.

However, after careful consideration and some guidance from a CPA, you can choose the best business structure for your business to secure maximum protection and tax savings.

 

DISCLAIMER: Any advice relating to finance, investments, stocks, companies, securities, or any other financial matters whatsoever reflects the private opinion of the person giving this advice. It is not the advice of a financial, investment, or other expert. Fund&Grow, its employees, and representatives take no responsibility for any consequences resulting from following such advice. Anyone seeking professional advice is strongly advised to conduct their own research or consult a professional financial adviser. Do not disregard professional financial opinion or make any financial decisions based on what you may read in Fund&Grow's Blog. You are solely responsible for any investment or other finance-related decisions you make.

 

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