Everything You Need to Know about Corporate Income Tax

Paying taxes is inevitable. It’s an inexorable social obligation that both private citizens and businesses must willingly comply with. Avoiding such an obligation, likewise known as tax evasion, can get you subjected to sanctions imposed by your state.

For corporations to stay operational, corporate income tax must be settled in compliance with state and federal requirements. It is one of the most common types of taxes that these entities are obliged to defray based on their profits.

 

To get a better picture, here’s a quick rundown of everything you need to know about corporate income tax.

 

What is a Corporate Income Tax?

A corporate income tax is imposed by the state and federal governments depending on a corporation’s net profits. It refers to the surplus of receipts over allowable costs, including revenue subtracted by general and administrative expenses, costs of goods sold, depreciation, and other operating costs. 

Generally, corporate tax rates may either be determined by the federal or state government. Federal tax rates are considered the flat rate applicable to all businesses. The latter, on the other hand, varies from state to state. 

 

Corporations are required to settle their income taxes since they are considered separate legal entities, which means owners are not liable for the debts and actions of their corporations. 

 

To put it simply, corporations are required to pay taxes that are separate from their owners. These legal entities must then submit a tally of their overall profits and losses through the so-called Corporation Income Tax Return. 

Federal Corporate Income Taxes

 

Nowadays, the federal corporate tax rate is at 21% of the taxable income of the business which refers to deducted value from the revenue and the expenses. The government agency responsible for the payment and collection of federal corporate taxes is the Internal Revenue Service.

 

For example, a  business with annual revenue of $250,000 and $55,000 expenses should pay $40,950 federal corporate taxes. 

 

Before the ratification of the Tax Cuts and Jobs Act of 2017, the tax rate imposed by the federal government was 35%.

 

Surprisingly, the United State’s corporate income tax is the country’s third-highest source of federal revenue, next to individual income taxes and payroll taxes. In 2017, it generated $297 billion from the income taxes of different corporations or 9% of the overall revenue of the federal government.

With the changes brought by the Tax Cuts and Jobs Act of 2017, corporations are now required to only pay at least 60% of their previous tax responsibilities based on the current and former rates. 

Therefore, we highly recommend you file your federal corporate income tax online or fill out IRS Form 1120. Remember that corporations with over 250 returns every year and those with over $10 million assets may only file through the web.

 

State-Level Corporate Income Taxes

While many states have additional tax requirements for corporations, some do not levy this type of tax rate. In total, corporate income taxes are collected in 44 states.  

Wyoming and South Dakota, for example, do not implement state corporate income taxes. On the other hand, gross receipts (also known as turnover taxes) are levied by Washington, Texas, Nevada, and Ohio instead of corporate taxes. 

Typically, this type of income tax can go as high as 1 to 12% based on how much a business earns. You’ll want to check the state corporate income tax rates of your state to avoid any problems. 

Remarkably, gross receipts prohibit businesses to deduct their expenses. This tax is levied on every business transaction, including engagements with consumers, contractors, businesses, and others. 

Moreover, corporate entities are mandated by state laws to pay their taxes, whether they are selling, buying, or incurring losses. 

Delaware collects both corporate income taxes and gross receipts. Meanwhile, Virginia, Pennsylvania, and West Virginia allow payment of gross receipts locally and state-level corporate income tax. 

 

Corporate Tax Deductions

Ordinary and necessary business expenditures are allowed to be deducted from a corporation’s taxable income, including other investments and real estate acquisition for income generation. 

Other deductibles are employee salaries, tuition reimbursement, health benefits, and even bonuses. Corporations may also minimize taxable income by subtracting travel expenses, insurance, bad debts, sales taxes, interest payments, and other forms of taxes. 

Furthermore, reduction of fees for tax preparation, legal services, and advertising costs are also allowed. 

Note, however, that you are barred from just deducting any type of expenses to your taxable income. 

To reduce corporate burdens, many corporations rely on tax professionals to find loopholes in the tax code. They can often find ambiguities to the law which drive the tax rate down to at least 18%. 

 

Double Taxation

Corporations are subject to so-called “double taxation.” With this legally accepted concept, the taxable income that has already been levied on the corporate level is taxed again – this time, by the company’s shareholders. 

A corporation’s shareholder pays personal income taxes depending on the dividends distributed by the business and the capital gains from selling shares, with a maximum rate of 23.8%.

In a nutshell, corporate earnings are levied twice, including the same income. Corporate double taxation is a common practice not only in the United States but also in many countries around the world. 

Some people, however, invoke that corporate double taxation levies the same income stream twice. The generally accepted notion, however, is that corporations are separate legal entities from the individual owners of the company which justifies the taxation on the corporate earnings and dividends.

 

Advantages of Corporate Income Taxes

Business owners may benefit from paying income taxes for their corporation, especially when it comes to individual returns. Medical insurance for their families, retirement plans, and tax-deferred trusts may easily be deducted from a corporate entity’s taxable income.

Unlike sole proprietors who must present evidence of their intent to gain profit, corporations may decrease their entire amount of losses without too many hassles.

Lastly, the corporation’s profit may be left within this legal entity which makes tax planning easier. It may also help build potential tax advantages in the future.

Final Thoughts

Corporate income taxes may sound intimidating, but it’s one of the most important aspects of a country’s economic integrity. Of course, people should understand the ins and outs of paying both federal and state taxes as well as the sanctions and fines when these legal obligations are left unsettled. 

With the reduction of the corporate income tax to 21% (from the previous 35% rate), it’s probably the best time to establish your own business. However, consulting a tax expert won’t hurt, especially if you want to avoid possible tax pitfalls and save more money and time in the long run.

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