Regular individual taxes are confusing enough that most of us turn to professionals to help us understand the tax code. But corporate income taxes take complicated to a whole new level.
Corporations operate as legal individuals with all the tax rights that come with that status. But unlike individuals, they have millions or billions of dollars to invest in getting themselves the best deal on taxes. Read on to learn more about the tax benefits a corporation can reap and the steps they can take to drop their tax rates as low as possible.
3 Types of Corporation Structures
Corporations are businesses that operate as separate legal entities from their owners. They have most of the rights of an individual citizen, with the exceptions being things like voting, marriage, death, and the like. They can own assets, enter contracts, borrow and loan money, sue and be sued, and pay taxes.
Corporate tax laws vary state to state, as do the various privileges these organizations have. Some people incorporate a business in one state because of their corporate policies and then operate out of another state. This is legal under specific circumstances, but usually, these businesses must pay an additional fee for this privilege.
1. Limited Liability Corporations
There are a few different kinds of corporations, the smallest of which is a limited liability corporation. People usually create these to protect their personal assets in case their business gets sued. Even if a customer wins a huge settlement, the business owner’s personal property isn’t up for grabs in the case.
An LLC is sort of a hybrid form of corporations. It provides some of the advantages of a full corporation, but it’s easier to set up. Almost anyone can set up an LLC, including individuals, other corporations or LLCs, or foreign entities and people.
2. S Corporations
S corporations are one subdivision of the corporate structure. These businesses choose to pass their corporate income, losses, deductions, and credits to their shareholders for tax purposes. This means the shareholders in the company assess any gains or losses from their share of the company on their personal taxes.
One of the primary benefits of operating as an S corporation is that the business does not pay income taxes. Passing everything on to their shareholders allows S corporations to avoid double taxation. These corporations are small – they must have less than 100 shareholders to qualify.
3. C Corporations
C corporations are the most classic and most common type of corporation. These organizations do pay business taxes, as well as the owners of the company paying personal taxes on any income they get from the business. But this double taxation situation comes with some perks for the business.
C corporations are able to reinvest profits in the company at a significantly lower corporate tax rate. It also has no limits on the number of shareholders in the company. This allows these companies to grow indefinitely.
Ten Common Write-offs on Corporate Income Taxes
1. Carrying Profits and Losses Forward and Backward
Operating as a corporation has always come with certain benefits, one of which is the ability to carry profits and losses. For LLCs and S corporations, the fiscal year runs from January 1 to December 31. But C corporations get to decide when they want their fiscal year to begin and end.
This flexibility may not seem like a big deal, but it allows corporations to take their profits and losses at the most opportune times. They can also carry losses forward over several years if they like. This is especially crucial for startups, which may see several years of losses before they start getting back into the black.
2. Accumulating Funds for Future Expansion at a Lower Cost
We mentioned earlier that C corporations can reinvest their profits in the company at a lower tax rate. With S corporations, any profits that the company makes pass through to the shareholders, which bumps them into a higher tax bracket. This means higher tax rates even if they put that money back into the company.
But C corporations allow shareholders to keep their earnings in the company and stay in a lower tax bracket. They are effectively shifting their wealth into the company where they can leave it to grow until they withdraw it at a later date. This allows the company to grow more without having to pay as much in taxes.
3. Writing Off Salaries and Bonuses
In a C corporation, shareholders can serve as salaried employees. In fact, many corporations offer company stocks as a benefit to their employees. The salaries the corporation pays to these employees are subject to payroll taxes and Social Security and Medicare contributions.
C corporations can deduct the full amount that they pay in payroll taxes from their corporate taxes. And they can pay their employees enough that there is no taxable income left at the end of the fiscal year. This also helps shareholders avoid being taxed twice on their dividends from the company.
4. Deducting Medical Premiums and Fringe Benefits
Providing fringe benefits to employees can provide huge benefits to C corporations. As long as benefits like medical reimbursement plans and premiums for health, long-term care, and disability insurance are available to all employees, 100 percent of those costs can be written off. This also benefits the employees since they receive these benefits tax-free.
5. Writing Off Charitable Contributions
Because corporations operate legally as individuals, they can get hefty tax write-offs for charitable contributions. There are limits to these deductions, but like anything else, there are loopholes that companies can exploit.
On paper, a C corporation can only deduct up to 10 percent of their taxable income given in charitable contributions. But amounts given over that limit can be carried over the next five years of taxes. C corporations are the only kind of business that can take these deductions.
6. The Pass-Through Business Deduction
On December 22, 2017, Donald Trump signed the Tax Cuts and Jobs Act into law. Among other things, it dropped the corporate tax rate to 21 percent, the lowest it’s been since 1939. But it also initiated a pass-through deduction for qualified business income.
Pass-through businesses are companies where profits pass through directly to the owners, such as in S corporations and sole proprietorships. Under the TCJA, these companies are eligible for a 20 percent deduction on qualifying income. This deduction is valid until 2025 and has an income cap of $160,725 for singles and $321,400 for joint filers.
7. Deductible Interest Expenses
The TCJA also changed how corporations can deduct interest expenses from their taxes. For the first four years, corporate income is based on earnings before interest, tax, depreciation, and amortization. Beginning in the fifth year, that swaps to just earnings before interest and taxes.
The TCJA limits corporations’ ability to deduct interest expenses to 30 percent of their income. This means it will cost financial organizations more to borrow money. They’re less likely to issue bonds and buy back their own stock under this new policy.
8. Deducting Depreciable Assets
Companies can deduct the cost of assets that depreciate over time. So if a corporation buys a car, they could amortize the car over the course of several years after the purchase. But the TCJA made it possible for corporations to deduct the entire cost of that car in the first year that it’s purchased.
This rule doesn’t apply to assets like buildings since they’re less likely to depreciate over time. The equipment must be purchased between September 27, 2017, and January 1, 2023, to qualify for the new policy. But this makes it easier for corporations to get larger tax cuts for the equipment they purchase each year.
9. Carried Interest Profits
Carried interest is an incentive designed to encourage fund managers and general partners to improve a hedge fund or private equity fund’s overall performance. These managers and partners can get a cut of the profits from a fund regardless of whether they contributed any initial money to the fund. The TCJA stiffened the requirements for managers and partners to get these profits.
Under the new law, carried interest is taxed at 23.8 percent. In the past, it’s been taxed at the top income tax rate and the firm must have held the asset for at least a year. Now that requirement has been extended to three years.
10. The Corporate Alternative Minimum Tax
Many corporations have accountants who help them figure out ways to manage deductions to drop their tax rate as low as possible. In fact, last year, Amazon, the most profitable company in the world, paid $0 in income taxes. Before the TCJA, there was an alternative minimum tax rate of 20 percent that kicked in if a corporation finagled their way into a tax rate below 20 percent.
The TCJA eliminated the corporate alternative minimum tax rate. Now corporations can drop their taxes as low as they can contrive, which is how Amazon was able to get away with paying no taxes on more than a billion dollars in profits last year. In fact, most corporations pay an average 18 percent effective tax rate.
Tax Treatment of Global Corporations
The TCJA also changed the way that global corporations are taxed. The hope was that by allowing companies to pay a one-time tax rate of 15.5 percent on repatriated cash and 8 percent on repatriated assets, these corporations would bring their assets back to the U.S.
In the past, corporations haven’t paid taxes on assets until they brought them home, so they chose to reinvest that money outside the U.S. Unfortunately, a similar tax break in 2004 didn’t do anything to boost the U.S. economy. Companies reinvested that money in their shareholders instead of their employees, keeping the wealth concentrated among the top 1 percent.
How Corporate Income Taxes Are Avoided
You may be wondering how it is that despite the fact that the corporate tax rate is 21 percent, companies pay only 18 percent on average. These corporations are extraordinarily skilled at manipulating the tax code. And almost half of all corporations are S corporations that can pass their profits through to their shareholders and avoid corporate taxation.
Multinational companies have also become very good at maintaining their finances so they make more money at home without having to pay the taxes. The introduction of the TCJA has hurt some of these companies, who have had to find a new strategy to manage their international dealings. But pharmaceutical and tech companies are earning money hand over fist from the new laws.
Different State Rates
In addition to federal income taxes, corporations also have to pay taxes to the state in which they’re based. These state tax rates can vary wildly depending on the state’s particular economic approach. Some states don’t have any corporate tax at all, while states like Iowa tax companies an additional 12 percent on top of federal taxes.
The following states don’t have any corporate tax rates at all:
- South Dakota,
- and Ohio
Colorado offers the next-lowest tax rate at 4.6 percent, followed closely by Mississippi, Utah, and South Carolina at 5 percent. The states with the highest corporate tax rates, all-around 10 percent are as follows:
- and Alaska.
Get Professional Help With Your Corporate Income Taxes
Corporate income taxes are complicated, expanding in complexity every year. The fact that corporations are businesses that can operate as individuals provides many tax privileges. And based on the current political administration’s viewpoint, that trend is likely to continue for the next year or two at least.
If you’d like some help figuring out corporate tax law, check out the rest of our site at Silver Tax Group. We’re real tax attorneys who provide everything from emergency tax services to audit defense. Contact us today and learn how we can help you get the best deal out of your taxes this year.