The Federal Tax Rate for U.S. Corporations: How Does Corporate Taxation Work?
Just like households and individuals are required to file tax returns, corporations must claim income with the IRS too. However, a corporation’s tax rates and responsibilities are different than they are for individuals. These business entities also have distinct deductions and taxation laws they’re expected to follow when operating in the U.S.
The Tax Cuts and Jobs Act (TCJA) was signed into law in December 2017 and it made significant changes to corporation tax law, which hasn’t been edited in decades. Most notably, the TCJA reduced the US corporate tax rate that corporations are responsible for paying from 35% to 21%. According to the Congressional Budget Office, in fiscal 2017, the corporate income tax provided the federal government with $297 billion, which accounted for about 9% of total federal revenue.
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What Is a Corporate Tax?
A corporate tax is a fee levied by state and federal governments on a corporation’s profits, and is also referred to as a company tax. The amount that’s due to the government is calculated based on the profit the company earned throughout the year, minus allowable deductions and credits.
State governments are in charge of setting their own corporate tax rates and procedures. For example, according to the Tax Foundation, in 2018, North Carolina had a state corporate tax rate of 2.5%, while Iowa had a rate set at 9%. Most states charge corporate income taxes, but Nevada, Washington, Ohio, and Texas actually tax corporate gross receipts. Calculations from the Tax Policy Center show that in 2016, states collected $46 billion from corporate income taxes.
With the freedom to create their own company tax legislation and rates, state governments can use this power to incentivize corporations to take up residence in their local communities. With more corporations in local areas, these states can provide residents with more employment opportunities and eventually may experience growth. Additional corporations also means more corporate taxes are collected, increasing the local government’s financial abilities to improve local communities.
Does Every Company Have to Pay a Corporate Tax?
A corporation is formed when a group of stakeholders who hold stock in the company decide to come together to pursue a common goal. Most corporations are focused on providing a return for their shareholders, while some are non-profit.
The type of incorporation created affects how corporate tax is calculated. For example, an S-corporation is referred to as a “pass-through tax entity” and has a special election with the IRS. S-corporations do not pay corporate taxes, while C-corporations are responsible for paying these taxes. There are other common business classifications that can affect corporate taxation, including:
- Limited Liability Company (LLC).
- General Partnership.
- B Corporation.
- Close Corporation.
- Nonprofit Corporation.
- Cooperative Business.
- Sole Proprietorship.
Some of these companies are responsible for paying corporate taxes while others are taxed at individual rates.
Businesses Taxed at the Corporate Rate
C corporations are the only type of business entity that is taxed at the corporate rate. While corporate employees are taxed at the employee rate, shareholders of the corporation are responsible for paying taxes at the corporate rate. This type of business entity is not considered a “pass through” corporation, meaning its members do not pass taxes through their personal tax filings. Therefore, this business’s profits are subject to the current corporate tax rate.
Businesses Taxed at the Individual Rate
- Sole Proprietorship. Self-employed or independent contractors who transfer business income to personal tax returns and pay taxes at the personal rate.
- Partnership. Business partners who are taxed on their shares of income at personal tax rates.
- LLC. A single-member LLC files taxes as a sole proprietorship, while other LLCs are taxed as different business entities by the IRS, depending on how many members are included. LLCs can elect to file corporate taxes, but it’s rare for members to choose this option. Although LLCs are treated like partnerships at the federal level, in some states, they may be subject to additional corporate tax laws.
- S-Corporation. Although it has “corporation” in the name, an S-corporation is a special type of entity that is still taxed at the individual rate. For tax purposes, S-corporations are treated similarly to LLCs. Shareholders file taxes through personal returns.
What Are Corporate Tax Brackets?
The corporate tax brackets that companies fall into depends on the taxable income they earned throughout the year. The more taxable income a company earned throughout the year, the more tax it will owe. Most corporations file a tax return annually, but pay estimated taxes quarterly.
Corporate tax brackets are an example of the progressive taxation system at work, which charges a higher tax rate to those earning more income and a lower tax rate to those earning less. This system can help small businesses to grow by reducing their tax liability. However, critics say the system can inhibit and discourage business growth and profit. They’re worried that corporations will intentionally stunt their own growth so they don’t fall into a higher corporate tax bracket.
With individual households, the progressive taxation system can help low-income families from getting into tax debt. Proponents of the system agree that a flat-tax system can be unfair for low-income families who can’t afford high tax rates. With the progressive system, only wealthy families are responsible for paying higher tax rates.
What Are Corporate Tax Breaks?
Corporations rarely pay the full amount that they owe in taxes, since federal and state governments usually offer several tax breaks. There are many tax benefits that corporations take advantage of, some of the most common being tax credits and deductions.
Tax credits allow corporations to reduce the amount of income they claim on their taxes. States set these tax credits to entice new corporations to their areas and to keep current businesses profitable and satisfied. In some cases, corporate tax credits may be provided to businesses in industries that states want to promote. For example, if New York wanted to increase the number of warehouse jobs in the state, it may set tax credit laws that cater to warehouse corporations, such as Amazon, to lure them into the state. These are sometimes referred to as “job creation tax credits.”
Corporations are allowed to reduce their taxable income by applying tax deductions. Any expenses the corporation had over the year to keep the business running can be deducted from the taxable income. For example, a corporation can deduct:
- Employee salaries.
- Health benefits.
- Tuition reimbursements.
- Insurance premiums.
- Travel expenses.
- Debt payments.
- Legal service fees.
- Advertising costs.
With reductions in taxable income, corporations can qualify for lower tax brackets and may be subject to a lower corporate tax rate.
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