Corporation taxes, also known as company tax, is a direct tax that is required to be paid on the income or capital of corporations. These taxes are specified by the country in which the corporation exists, but there may also be local state taxes as well. Corporate tax is a levy that is placed on its profits by the government. In America, there are always federal taxes on corporate income, but not always state taxes.
How Corporate Taxes Work
Corporate taxes are one way that the government is able to generate revenue from corporations. They are paid on all of the operating earnings of a corporation, which is all of the revenue minus a few items:
- Operating costs
- Cost of goods sold
- General and administration
- Selling and marketing
- Research and development
In the United States, corporations are required to pay a tax rate of 21% in 2020. This is reduced from 35% by the 2017 Tax Cuts and Jobs Act. In 2019 alone, the corporate income tax raised $230.2 billion which accounted for 6.6% of total federal revenue, while in 2017 this was 9%.
Taxes That Need to be Paid by Corporations
All U.S corporations must file a corporate tax return, known as an IRS Form 1120. This along with taxes on corporate income is due on March 15th, or in quarterly payments to the IRS by the 15th day of the 4th, 6th, 9th, and 12th months of the tax year.
Federal corporation taxes are the same in every state, but state taxes vary.In Delaware, the corporate income tax is 6% for C corporations and any taxpayers taxed as corporations federally.
Shareholder tax payments must be paid by any owners who work for the corporation. These are essentially personal income taxes being paid on the salaries or bonuses earned, which will be deducted from the overall income taxes of the corporation.
S Corporation Taxes
Regular corporations are called C-corporations, but a corporation that has elected S corporation status to pay their taxes will do so in a different manner. An S-corporation pays taxes like a partnership or limited liability company (LLC). When this occurs, all of the corporate profits and losses are reported on the individual owner’s personal income tax returns.
Dividends are often distributed to the owners, and they are required to report and pay income tax on these amounts. Despite this, dividends are not tax-deductible, so the corporation will be taxed twice, once to the corporation and again to the shareholders.
What Expenses are Tax Deductible
Corporations are permitted to reduce some taxable income by certain business expenses. Tax deductions essentially help to reduce the taxable profits of a corporation. This includes all expenses required for the operation of the business, along with a few other items.
- Real estate purchased with the intent of generating income
- Operating expenses
- Employee salaries
- Advertising and marketing
- Benefits to employees
- Tuition reimbursement
- Insurance premiums
- Travel expenses
- Bad debts
- Sales taxes
- Fuel tax
- Excise tax
- Tax preparation
- Legal services
- Bookkeeping costs
No Pass-Through Tax Deduction
Because of the Tax Cuts and Jobs Act, there is a new income tax deduction for pass-through entities. Between 2018 through 2025, owners of sole proprietorships, partnerships, limited liability companies, and S corporations are allowed to deduct up to 20% of their net income for income tax purposes. Regular C corporations are not pass-through entities, therefore this deduction is not allowed.
How Business Owners Benefit from Corporate Taxation
Although reporting and paying taxes on a separate corporate tax return might take more time, there are a huge amount of benefits.
Lower Corporate Tax Rates
Because corporations now pay a flat tax of 21% on all their profits, this is a lower rate than the top five individual income tax rates. Especially if corporations are planning to hold on to profits in the business at the end of the year. On the other hand, sole proprietorships, partnerships, and LLCs must always pay taxes on all business profits at their own individual income tax rates, regardless of if they pay themselves out or not. You may leave up to $250,000 at one time in your corporation without facing tax penalties.
Tax-Free Fringe Benefits
Another benefit of corporations is the ability to deduct the full cost of fringe benefits that are provided to employees. This will specifically include the business owners, meaning these benefits can be deducted from the overall corporate taxes.
What to Put in Your Shareholder Agreement
The above is only some of what should be included in the agreement. Each company is different and should be treated as such. In many cases you may need to outline more in the agreement in order to support your business. The most essential part of a shareholders agreement is that it is detailed enough so everyone understands their role, and the outcome of serious changes.