Taxes may be considered an integral part of any organization’s operations. It represents part of the major firm’s outgoings, but you can save money by selecting a tax regime that complies with the peculiarities of the venture.
A corporation stands for the only category of a legal entity obliged to submit its own tax statement under the general principle. One may select the default C-corporation treatment or switch to “flow-through” S-corporation taxation. Let’s look at the features of each of these options in a little more detail to assist you in determining the best taxation for the firm.
Corporate Tax: What Does It Mean?
Corporations are taxed in another way compared to sole proprietorships, partnerships, or LLCs. Unlike other practices of organizing a commercial activity, corporations are not “go-through” taxable units. That is to say, the IRS obligates them to pay corporate income tax under their names, which leads to double taxing. This is commonly known as a situation where a venture’s proceeds are taxed at the organization’s level as a whole and then allocated among shareholders.
Corporate tax means the one levied on the revenue of a corporation. Normally, the category of taxable gains covers retained income, like funds set aside for entity growth, as well as dividends of shareholders. Hence, a venture is taxed on all proceeds earned, less corporate expenses.
The exact tax rates hinge on the state where the venture operates. Some of them have extremely favorable tax conditions making them believed to be tax havens. Thereby, it is pivotal to clarify the tax standards before starting an entity.
How Does Corporate Taxation Work?
When you establish a corporation, you might select the optimal tax regime for it, which corresponds to today’s stage of your entity’s development and its goals. It’s not just a formality since the C-corp or S-corp system determines the number of significant aspects of how the venture functions. For instance, it affects the number and type of possible shareholders, class of stock, tax expenses, benefits, and so forth. A suitable tax regime will accelerate the development of the firm and contribute to its future growth, so let’s look at the features of C-corp and S-corp taxation in greater depth.
By default, the IRS considers a corporation to be a stand-alone taxable unit distinct from its shareholders. The earnings of firms selecting to be taxed as a C-corp are taxed twice. First, an enterprise pays income tax at the corporate level, and then, the revenue is taxed again when it is distributed as dividends among the shareholders. Of course, filing separate tax returns on behalf of the organization takes money and time, but some organizations benefit from it. This method of taxation is especially popular among large entities with significant revenues.
Any venture needs investments, so corporations are permitted to deduct their outgoings from taxable earnings. They are as follows:
- Startup and maintenance costs;
- Employee wages and bonuses;
- Costs for the acquisition of products;
- Purchase of medical and pension plans, etc.
Shareholder Tax Liabilities
Generally, the owners are considered self-employed rather than employees. Nonetheless, a C-corp gives its shareholders this option. If a corporation pays its owner a salary, these funds are subject to individual income tax.
Corporation Tax Payments
To submit the corporate tax return, you should prepare an IRS Form 1120. The expected annual income should be divided by 4 quarters and paid no later than the 15th day of the 4th, 6th, 9th, and 12th month of the firm’s tax year. If your venture’s tax year coincides with the calendar one, the deadlines for paying tax are:
- April 15;
- June 15;
- September 15;
- December 15.
Dividends are initially part of the corporation’s proceeds and are not subject to a tax deduction, so they fall under corporate income tax. Then, when the revenue is allocated to shareholders, the latter should indicate it in their personal tax returns, paying tax at the rate for individuals.
To bypass double taxation and related expenses, some owners become employees. In place of dividends, they receive wages and bonuses, allowing the firm to claim a tax deduction.
The taxation system of an S-corp is similar to that of a partnership. In contrast to a C-corp, an S-corp is not taxed at the company level. Being a “flow-through” tax unit, such a firm transfers the responsibility to pay tax to its shareholders. The latter declare income and losses derived from commercial activities in their own tax returns.
Despite the benefits provided, an S-corp is not extremely widespread among entrepreneurs nowadays. The explanation is that maintaining such an organization is connected with numerous technicalities and restrictions for shareholders.
No Pass-Through Tax Deduction
Thanks to the program in force until 2025, the owners of “go-through” ventures including S-corps are entitled to some benefits. For example, they may get a tax deduction of 20% of the firm’s net revenue. It allows the organization to save significantly on tax payments and plan its budget more effectively. Enterprises taxed under the C-corp type are not eligible for such a deduction.
Strengths of a Corporate Tax
Today, most corporations are taxed as C-corps, even though this leads to double taxation. Naturally, filing corporate reports requires an additional investment of effort and money, but this option has its merits. In return, such entities get certain perks contributing to the growth and development of the organization.
The first thing to highlight among the pluses of such a tax regime is the lower rate. While individual income tax rates can be as high as 37%, the corporate tax rate stands at 21%. Of course, the obligation for shareholders to pay tax on dividends increases costs, making the lower corporate rate less attractive. Nevertheless, corporate taxation is relevant for ventures reinvesting a significant portion of their annual revenues. By refusing to pay dividends or reducing their amount, you will cut the taxable sum, saving money and increasing the value of the firm. This is a definite strength of C-corps, as other structures do not have such an opportunity. Sole proprietorships, partnerships, and LLCs pay taxes on all revenue earned, regardless of its distribution. Nonetheless, it is vital to plan your allocations to avoid tax on accumulated C-corp profits. This accrues when a company withholds funds over reasonable needs.
The simplified procedure for deducting corporate losses is also a strength of C-corps and gives it an advantage over sole proprietorships.
In addition to the listed above, corporations can take advantage of various deductions, including health insurance for owners and their family members. Moreover, they are eligible for such benefits as special pension plans and tax-deferred trusts. Deferred tax status applies only to investment earnings, such as dividends or interests. They can accumulate tax-free until the profits are garnered. In the long run, such tax-free income growth can produce significant savings, increasing the investor’s revenue.
Significantly, some of the corporation’s benefits related to the expenses of operating a company are not tax-deductible. This distinguishes corporations from other structures, the owners of which are obligated to pay tax on the received benefits.