Corporations are taxed just like people and pay income taxes on their earnings. However, corporations use different tax forms and pay different corporate income tax rates.
What is taxed?
A corporation is taxed on its net income, or its revenue minus expenses. Revenue is what the corporation earns for selling goods or providing services. Expenses are referred to as deductions. The corporation is allowed to deduct anything necessary to conduct business. However, certain deductions are limited. For example, the IRS limits the business interest expense deduction for some businesses.
Corporate tax rates
Currently, there is a flat corporate income tax rate of 21% in the U.S. In the past, it has been graduated. One benefit of a corporation's "intangible" nature is that it can easily establish domicile in another country. So when the U.S. raises the tax rate above the rates in other countries, some corporations will establish domicile in another country to pay the lowest tax rate possible.
That could change in the near future. The leaders of 136 countries have agreed to reform the global tax system and crack down on tax havens. The Organisation for Economic Co-operation and Development (OECD) recently agrees to establish a minimum global tax rate of 15%. However, this rate would only apply to companies with global annual sales of more than 750 million euros (approximately $868 million).
The OECD's goal is to have the agreement fully activated by 2023. Once enacted, governments could still set a lower corporate tax rate, but if a corporation pays a low tax rate in a particular company, its home government could "top up" their taxes to reach the 15% minimum. This would eliminate the benefits of shifting profits to countries with lower corporate tax rates.
Form 1120, U.S. Corporate Income Tax
Just like individuals, corporations also have to file an annual tax return. Corporations file Form 1120, U.S. Corporate Income Tax Return.
Form 1120 currently spans six pages, and most corporations must attach additional schedules to the main form, such as:
- Form 1125-A, Cost of Goods Sold
- Schedule D, Capital Gains and Losses
- Form 4797, Sales of Business Property
- Form 1125-E, Compensation of Officers
- Form 4562, Depreciation and Amortization
- Form 3800, General Business Credit
For corporations that operate on a calendar year, the deadline for filing Form 1120 is April 15. For fiscal year corporations, the filing deadline is the 15th day of the fourth month following the end of the company's fiscal year.
The IRS Instructions for Form 1120 include line-by-line instructions for preparing the corporate tax return. However, the form is complicated, and it's best to have it prepared by a CPA or another qualified tax preparer.
One issue with the corporate income tax is that it leads to double taxation on the same earnings. For instance, assume a corporation has one shareholder and $100,000 of taxable income. If the tax rate is 21%, then the corporation will pay $21,000 for the tax year. If the corporation then pays the remaining $79,000 to the shareholder, that $79,000 will be taxed as a dividend on the shareholder's personal tax return. Say the dividends are taxed at 15% on the shareholder's return. That amounts to another $11,850 in taxes. The effective rate on the original $100,000 ends up being just under 33%.
One way for smaller corporations to eliminate this double taxation issue is to elect to be an S-Corporation, which is a pass-through entity.