Corporations have many expenses and one of them is taxes. Every corporation pays taxes on their taxable income. How much corporations pay in taxes hinges on several factors like the country or state the business operates in as well as tax laws for those locations.
Corporate income taxes are the third largest source of tax revenue in the U.S., so it helps fund programs and services for citizens like healthcare, education, infrastructure, and social security.
How Do Corporate Taxes Work?
Corporations are taxed on their profit or net income, which is the number they arrive at after deducting expenses from sales or revenue earned. C Corporations use IRS Form 120 to calculate their tax liability. With this tax form, corporations are able to include information like income, gains, losses, deductions, and credits to determine how much they’ll pay the IRS.
State and federal corporate taxes have changed over the years and can continue to go up or down. The current federal corporate tax rate is a flat fee of 21%, and it has been so since the Tax Cuts and Jobs Act of 2017 was passed. That said, states can also tax corporations or choose to opt-out altogether. South Dakota and Wyoming are the only two states that don’t charge both corporate income taxes and gross receipt taxes. Nevada, Ohio, Texas, and Washington don’t have a corporate income tax but do have a gross receipt tax.
Double Taxation
C Corporations are the only business structures that experience double taxation. Double taxation is when corporations pay taxes on the same income or profit twice. How it works is a corporation is first taxed when they make income and then shareholders pay taxes when they receive dividends. Shareholders pay their individual tax rates on their dividends. Unfortunately, shareholders are unable to deduct business losses on their tax returns, unlike with S corps.
A way to avoid double taxation is by organizing the business as a pass through entity as these structures allow income to flow directly to the owners and avoid shareholder dividend payments. Examples of pass through entities include sole proprietorships, partnerships, limited liability companies, and S corporations. With all of these structures, owners pay taxes at their personal tax rate but not at the corporate level.
Reducing Corporate Taxes
While double taxation isn’t always avoidable, there are ways for corporations to reduce their corporate taxes and overall tax liability.
Some common strategies include through deductions, subsidies, business tax credits, and tax loopholes. Here are brief explanations of a few.
Tax deductions
Tax deductions reduce a corporation’s income before they calculate taxes. It could potentially put a corporation into a lower tax bracket, reducing its overall tax liability. Examples of tax deductions corporations can utilize include payroll taxes, utilities, net operating losses, asset depreciation or rent. Keep in mind that corporations aren’t eligible for tax deductions if they distribute dividends to shareholders.
Tax credits
Corporate tax credits enable companies to reduce their taxes by deducting some expenses dollar-for-dollar. There are a range of credits available such as the investment credit, work opportunity credit, and the general business credit.
Business owners looking for ways to navigate corporate taxes and double taxation should consider speaking to a tax or financial advisor.
