Understanding Taxes for C Corporations
The tax structure of a C corporation is probably its most talked about feature. Most often, it is the tax that the company pays both for income and for dividend distributed that is discussed.
But do you know that C Corporations are also afforded certain privileges in terms of taxation?
Companies that incorporate as C corporations -- which often are large ones -- enjoy the privilege of unlimited lifespan, and the freedom to have as many shareholders as they want. They also get additional capital more easily through the issuance of stocks and investments from venture capitalists. In addition, their owners are afforded liability protection as they are considered separate and distinct entities from their businesses. It means they and their assets are shielded from liabilities that they must otherwise face under a proprietorship or partnership. But a C corporation has also its downsides, the most major of which concerns double taxation.
A regular corporation is taxed on its profits, of course. But in addition, when it distributes that profit as dividends, the shareholders receiving the amount also report that money as personal income. As a result, the same amount is taxed twice. Under an S corporation -- another form of incorporation – all of the profit figure just goes to the owners’ personal income tax return, and so corporate tax payment is skipped, avoiding double taxation.
On the other hand, there are also privileges that C Corporations enjoy, some of which they can use to minimize the effect of double taxation:
- Because the amount distributed as dividends was subjected to the first taxation as part of the company’s income, the taxable dividend for C corporation owners is considered “qualified dividend,” which by definition, is taxed at 5-15%, whichever is lower than the regular income tax rate.
- For corporations reporting income below $50,000, the tax is only 15%. Whereas, for an S corporation, limited liability company or sole proprietorship, that amount will be higher. The key therefore in limiting a corporation's taxable income is to avail of the deductions available for C corporations. For one, salary is deductible as a business expense and so shareholders, who are acting as directors and employees, can choose to pay salaries and bonuses in amounts that could lower profits and reduce or eliminate taxable income at a corporate level. A factor to consider when determining salaries to be deducted from money coming into the company: the tax on the first $75,000 of corporate profits is lower than tax for the individual's income.
- C-corporations are allowed to determine how much to give out as dividends and how much to retain as earnings. This gives corporate owners the freedom to set what amount to subject to corporate taxation and what amount to subject to individual income taxation.
- A corporation may also avail of tax breaks for employee benefit plans like health insurance and medical reimbursement. These deductions are not allowed or otherwise limited under sole proprietorship and partnership. Other expenses that can reduce taxable income are rents, repairs and maintenance, depreciation, donations and bad debts.
Alternative Minimum Tax
Aside from the regular tax, C corporations must also calculate alternative minimum tax annually. The higher of the two becomes the corporation's tax obligation for the year. The AMT is for taxpayers of a certain income bracket that enjoy special deductions and credits for particular expenses. The AMT is aimed at ensuring that certain types of taxpayers pay at least their minimum obligation. This is basically a flat 20%.
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