How Corporations are Taxed

How Corporations are Taxed

by Brette Sember, Esq., August 2017

They say that the only things certain in life are death and taxes, but for corporations, that may not always be true. Whether and how corporations are taxed depends on what kind of corporation they are.

Types of Corporations

There are two types of corporations: C corporations and S corporations. A C corp. is what you think of when you imagine a typical, big corporation. This is the type of corporation that is created when you form one without filing any additional documentation.

To classify as an S corporatiion, the corporation must file an election with the IRS after the corporation is formed. The S corp. is a typically smaller than most C corporations, with only one class of stock and no more than 100 shareholders. You must file the election with the IRS no more than two months and 15 days after the formation of your company (or the beginning of the tax year in which you wish to elect S corp. status). A majority of corporations, including many small businesses, are S corporations.

There are corporation tax filing differences depending on which type of corporation you choose.

C Corporation Taxes

You've probably heard that a corporation is like a person, and for C corporations that is true, because they are taxed in much the same way a person is. C corp. taxes are based on their profits. The C corp. must report to the IRS any money that is earned after business expenses are deducted, or money that the C corporation pays out in distributions to shareholders.

C corporations can take tax deductions on their C corp. tax return, so all of the costs involved in running their business, like employee salaries, benefits provided to employees, supplies, the costs of services the corporation uses, advertising, and all operating expenses are business expenses that get deducted from the corporation's income before paying its corporate taxes. C corporations must submit a tax filing each quarter to estimate their profits and pay estimated tax.

Double Taxation

One big complaint about C corporation tax law is that the corporation pays tax on its net profits, and then distributes dividends to its shareholders, who must pay income tax on those dividends on their personal tax returns, so that the money is actually taxed twice. However, small C corporations often don't pay dividends, and their shareholders are often corporate employees who receive salaries and bonuses, which are deductible by the corporation.

C Corp. Tax Rates

Federal corporate tax rates rates can reach 35 percent. Local and state taxes can raise the marginal corporate tax rate to 39 percent. But there are several tax brackets and, as you've probably heard, a number of ways to limit your corporate tax liability. The tax rate for most C corporations is between 12 and 28 percent. U.S. corporation tax rates are considered to be the highest in the world. Another key fact is that corporations are taxed not only on income earned in the U.S. but also on income the corporation earns anywhere in the world.

S Corporation Taxes

The S corporation tax return requirements differ from C corporation returns because S corporations don't pay income tax. Instead, the profits pass through to the shareholders, who are then taxed on the income at their personal rates on their income tax returns.

Losses are also passed through to shareholders, who claim them on their individual income tax returns as well.. In short, an S corp.'s profits are taxed in the same way as those of a partnership and many LLCs: through the individual owners and not at the entity level.

Choosing Your Corporation Type

There are benefits and drawbacks to both types of corporate tax filings.

While C corporations profits are subject to tax at both the corporate and individual level, C corporations don't have to distribute profits to shareholders annually. Profits can be retained by the corporation (often up to $250,000), delaying any tax liabilty for the shareholder.

S corp. taxes to be paid are paid only once, by the shareholders through their individual tax returns. An S corp. provides greater liability protection for the owners than a partnership, and avoids the double taxation requirement of C corporations.