Nobody loves paying taxes, but they’re inevitable, and if you want to continue doing business as a corporation, you need to pay them.
Not paying taxes could cost you your good standing, and if you let your corporate taxes go unchecked, your state could even dissolve your business.
The most well-known corporate tax is the corporate income tax, which is both a federal and state requirement. In this guide, we’ll fill you in on all things corporate income tax: how it works, how to pay it, what the rates are, and how you can reduce your tax burden.
How It Works
The corporate income tax is a tax on the net income of a business, not the gross income. Basically, you will only pay taxes on what you earn, not on every dollar that passes through your business, which is why you can deduct certain expenses from your income reports. (Read more on deductible expenses here).
A key feature of corporate income tax is that the tax is paid by the entity itself.
The tax applies to both C corporations and limited liability companies (LLCs) which choose to be taxed as corporations. In contrast, S corporations and most LLCs are considered pass-through entities, so they do not pay corporate income taxes.
Federal Corporate Income Taxes
The Internal Revenue Service handles the collection and payment of the federal corporate income tax. Currently, the tax rate is 21%, as set by the Tax Cuts and Jobs Act of 2017. Previously, this tax had a rate of 35%, and the 21% rate is actually the lowest rate for American corporate taxes since the 1930s. The corporate tax cut caused by this act is permanent, unless revoked and replaced by new legislation.
It might surprise you to hear that America’s corporate income tax is the nation’s third-highest source of revenue on the federal level, behind only individual income taxes and payroll taxes. This country generated $297 billion from corporate income taxes in 2017, which was 9% of the federal government’s overall revenue.
However, because of the Tax Cuts and Jobs Act of 2017, it will be interesting to see how severely this number drops in coming years, now that most corporations only have roughly 60% of the tax responsibilities they used to have under the previous rate.
To file and pay the federal corporate income tax, you can either file online or print and fill out IRS Form 1120. Corporations which file more than 250 returns each year are required to file online, and the same applies for corporations with more than $10 million in assets.
It’s also important to note that C corporations are subject to what’s commonly referred to as “double taxation.” This means that after taxes are paid on the corporate level, that same money is taxed again by the company’s individual shareholders. The shareholders pay personal income taxes on dividends distributed by the business, as well as on capital gains from selling shares in the corporation.
The tax rates on both dividends and capital gains have maximum rates of 23.8%.
State-Level Corporate Income Taxes
In most states, you’ll need to pay both the federal corporate income tax and your state’s corporate income tax. The rates for these taxes usually range from 3-12% of your net profits. You can usually pay using paper forms, or online by visiting your state’s website (typically through the Department of Revenue).
In total, 44 states have a corporate income tax. There are, however, a few states that levy a gross receipts tax instead: Nevada, Ohio, Texas, and Washington. These taxes (also called turnover taxes) are generally considered to create a greater tax burden.
For one, the gross receipts tax does not allow businesses to deduct their expenses. The tax itself is a tax on all transactions a business makes, including those with other businesses, consumers, contractors, and more. The corporation pays the tax regardless of whether they’re buying or selling, and the business pays the tax when there is a year of loss as well.
Some taxes charge both a gross receipts tax and a corporate income tax. For instance, Delaware has both forms of taxation, while Pennsylvania, Virginia, and West Virginia allow gross receipts at the local level on top of the state-level corporate income tax.
If your corporation is based in South Dakota or Wyoming, then you’re in luck, because these states do not charge either type of tax.
Reducing the Burden of Corporate Income Taxes
Like we mentioned earlier, corporate income tax is levied on your corporation’s net profits. You can deduct certain expenses, including employee wages, employee benefits, the costs of new equipment, and more.
Making these deductions essentially reduces your profit margin, and by making strategic investments in new capital for your business, you can lower your taxable income. Of course, this is not an “anything goes” deduction, because some expenses cannot be deducted. You can learn more about these deductions here.
Other “loopholes” exist in the tax code, but they can be very complicated. If you want to reduce your corporate tax burden, you should talk with a tax professional to be sure you do so legally and efficiently.
Overall, most corporations don’t pay the full 21% corporate tax rate — instead, many corporations find enough of these loopholes to keep their effective federal tax rate down in the 18% range.
The ins and outs of business taxes can be confusing, especially when it comes to corporate income tax. Understanding the basics of both federal and state taxes will help you avoid unwanted late fees and underpayment penalties.
This guide is just a starting point, however. If you have a specific question about your corporation’s tax responsibilities, we recommend that you consult with a tax professional in your area. Expert advice will help you save the most money and avoid potential tax pitfalls.
Overall, corporate income tax responsibilities are considerably lower than they were just a couple years ago, because of the Tax Cuts and Jobs Act of 2017 cutting rates from 35% down to 21%. Therefore, if you’re looking to get started with a new corporation, now is an especially affordable time to do just that.