Corporate Tax
| Author | Jeffrey Wilson |
| Pages | 1285-1289 |
Page 1285
There are four basic types of business entity:
corporations (C and S)
limited liability companies
partnerships (general and limited)
sole proprietorships
Basically, if someone is the only owner of a business, that person will be able to form any of the types except a partnership. If there are two or more owners, they will be able to form any business type except a sole proprietorship. Tax law is a large and complicated subject.
Corporations are taxed in a different manner than other business entities. In fact, corporations are the only types of business that pay income taxes on their profits. Conversely, partnerships, sole proprietorships, and limited liability companies (LLCs) are not taxed on business profits. Rather, the business profits "pass through" to the business' owners, who in turn report the business income (or losses) on their personal income tax returns.
Corporations are taxed separately from their individual owners. If a taxpayer's business is not incorporated, all the profits from the business will be taxed on the taxpayer's personal income tax return in the year that the profits were earned. Incorporating such a business may prove to be a good way to save on taxes, especially if the taxpayer intends to reinvest the profits in the business. For example, if a taxpayer's business is incorporated, the first $75,000 of the business's profits will be taxed at a lower rate than if the taxpayer claimed them on his or her personal income tax return. However, there are exceptions: personal service corporations like legal, accounting, consulting, and medical groups must pay a flat tax rate of 35 percent on their taxable income.
Corporations can deduct employee benefits, such as health insurance, disability, and up to $50,000 in life insurance. This deduction applies to owners who are also employees of the company. The IRS permits incorporated businesses to treat their owners as employees for benefits purposes, allowing these owners to take the tax deduction on their own as well as their employees' benefits. Conversely, owners of unincorporated businesses and sole-proprietorships cannot deduct their own benefits.
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Taxpayers cannot immediately claim on their personal income tax corporate losses on their incorporated businesses. Rather, they must wait until they can offset their losses by profits. This is particularly problematic for newer businesses because most new businesses produce very little revenue in their first few years and losses are common.
Corporations must file corporate tax returns every year. They are taxed on their profits at a corporate income tax rate. If a corporation expects to owe taxes, the IRS requires it to estimate the amount of tax due for the year and make payments to the IRS on a quarterly basis—in the months of April, June, September, and January.
If the corporation's owners work for the corporation, they will pay individual income taxes on their salaries and bonuses, just like regular employees of any business. Salaries and bonuses are deductible business expenses to the corporation, so the corporation can deduct those costs and does not pay taxes on them.
For corporations that distribute dividends to its owners, the owners must report and pay personal income tax on these amounts. Dividends are not tax-deductible, unlike salaries or bonuses. Moreover, the corporation must also pay taxes on dividends. Thus, dividends are taxed twice—once to the corporation and again to the shareholders.
Corporations frequently want or need to retain some of their profits at the end of the year. These funds can be used for a wide range of business activities such as expansion, development, or other purposes related to growth in the business. If the corporation does retain some of its profits, the corporation will be liable for taxes on that money at the appropriate corporate income tax rate. A corporation's owners can save money by retaining a portion of corporate profits in the company because the initial corporate income tax rates are lower than most owners' marginal income tax rates for the same amount of income. In contrast, owners of sole proprietorships, as well as partnerships and LLCs, are taxed on all business profits at their individual income tax rates, whether they take the profits out of the business or not.
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