Corporate tax in the United States
Encyclopedia
Corporate tax is imposed in the United States at the Federal, most state, and some local levels on the income of entities treated for tax purposes as corporations. Federal tax rates on corporate taxable income
vary from 15% to 35%. State and local taxes and rules vary by jurisdiction, though many are based on Federal concepts and definitions. Taxable income may differ from book income both as to timing of income and tax deductions and as to what is taxable. Corporations are also subject to a Federal Alternative Minimum Tax
and alternative state taxes. Like individuals, corporations must file tax returns every year. They must make quarterly estimated tax payments. Controlled groups of corporations may file a consolidated return.
Some corporate transactions are not taxable. These include most formations and some types of mergers, acquisitions, and liquidations. Shareholders of a corporation are taxed on dividends distributed by the corporation. Corporations may be subject to foreign income taxes, and may be granted a foreign tax credit
for such taxes.
Shareholders of most corporations are not taxed directly on corporate income, but must pay tax on dividend
s paid by the corporation. However, shareholders of S Corporations
and mutual funds are taxed currently on corporate income, and do not pay tax on dividends.
s having income or activities within the jurisdiction. For Federal purposes, an entity treated as a corporation and organized under the laws of any state is a domestic corporation. For state purposes, entities organized in that state are treated as domestic, and entities organized outside that state are treated as foreign.
Some types of corporations (S corporation
s, mutual funds, etc.) are not taxed at the corporate level, and their shareholders are taxed on the corporation's income as it is recognized. Corporations which are not S Corporations are known as C Corporation
s.
Domestic corporations are taxed on their worldwide income at the Federal and state levels. Corporate income tax is based on net taxable income
as defined under Federal or state law. Generally, taxable income for a corporation is gross income (business and possibly non-business receipts less cost of goods sold) less allowable tax deductions. Certain income, and some corporations, are subject to a tax exemption
. Also, tax deductions for interest and certain other expenses paid to related parties are subject to limitations.
Corporations may choose their tax year. Generally, a tax year must be 12 months or 52/53 weeks long. The tax year need not conform to the financial reporting year, and need not coincide with the calendar year, provided books are kept for the selected tax year. Corporations may change their tax year, which may require Internal Revenue Service
consent. Most state income taxes are determined on the same tax year as the Federal tax year.
Federal corporate income tax is imposed at graduated rates. The lower rate brackets are phased out at higher rates of income. All taxable income is subject to tax at 34% or 35% where taxable income exceeds $335,000. Tax rates imposed below the federal level vary widely by jurisdiction, from under 1% to over 16%. State and local income taxes are allowed as tax deductions in computing Federal taxable income.
Groups of companies
are permitted to file single returns for the members of a controlled group or unitary group, known as consolidated returns
, at the Federal level, and are allowed or required to do so by certain states. The consolidated return reports the members' combined taxable incomes and computes a combined tax. Where related parties do not file a consolidated return in a jurisdiction, they are subject to transfer pricing
rules. Under these rules, tax authorities may adjust prices charged between related parties.
Shareholders of corporations are taxed separately upon the distribution of corporate earnings and profits as a dividend
. Tax rates on dividends are at present lower than on ordinary income for both corporate and individual shareholders. To insure that shareholders pay tax on dividends, two withholding tax provisions may apply: withholding tax
on foreign shareholders, and “backup withholding” on certain domestic shareholders.
Corporations must file tax returns in all U.S. jurisdictions imposing an income tax. Such returns are a self assessment of tax. Corporate income tax is payable in advance installments, or estimated payments, at the Federal level and for many states.
Corporations may be subject to withholding tax
obligations upon making certain varieties of payments to others, including wages and distributions treated as dividends. These obligations are generally not the tax of the corporation, but the system may impose penalties on the corporation or its officers or employees for failing to withhold and pay over such taxes.
Most states tax domestic and foreign corporations on taxable income derived from business activities apportioned to the state on a formulary basis. Many states apply a "throw back" concept to tax domestic corporations on income not taxed by other states. Tax treaties do not apply to state taxes.
Under the U.S. constitution, states are prohibited from taxing income of a resident of another state unless the connection with the taxing state reach a certain level (called “nexus”). Most states do not tax non-business income of out of state corporations. Since the tax must be fairly apportioned, the states and localities compute income of out of state corporations (including those in foreign countries) taxable in the state by applying formulary apportionment
to the total business taxable income of the corporation. Many states use a formula based on ratios of property, payroll, and sales within the state to those items outside the state.
since. Corporate tax provisions are incorporated in Title 26 of the United States Code
, known as the Internal Revenue Code
. The present rate of tax on corporate income was adopted in the Tax Reform Act of 1986
.
issued the so-called “check-the-box” regulations in 1997 under which entities may make such choice by filing Form 8832. Absent such election, default classifications for domestic and foreign business entities, combined with voluntary entity elections to opt out of the default classifications (except in the case of “per se corporations” (as defined below)). If an entity not treated as a corporation has more than one equity owner and at least one equity owner does not have limited liability (e.g. a general partner
), it will be classified as a partnership (i.e. a pass-through), and if the entity has a single equity owner and the single owner does not have limited liability protection, it will be treated as a disregarded entity (i.e. a pass-through).
Some entities treated as corporations may make other elections that enable corporate income to be taxed only at the shareholder level, and not at the corporate level. Such entities are treated similarly to partnerships. The income of the entity is not taxed at the corporate level, and the members must pay tax on their share of the entity's income. These include:
(gross receipts and other income less cost of goods sold
) less tax deductions. Gross income of a corporation and business deductions are determined in much the same manner as for individuals. All income of a corporation is subject to the same Federal tax rate. However, corporations may reduce other Federal taxable income by a net capital loss and certain deductions are more limited. Certain deductions are available only to corporations. These include deductions for dividends received and amortization of organization expenses. Some states tax business income of a corporation differently than nonbusiness income.
Principles for recognizing income and deductions may differ from financial accounting principles. Key areas of difference include differences in the timing of income or deduction, tax exemption
for certain income, and disallowance or limitation of certain tax deductions. IRS rules require that these differences be disclosed in considerable detail for non-small corporations on Schedule M-3 to Form 1120.
This rate structure produces a flat 34% tax rate on incomes from $335,000 to $10,000,000, gradually increasing to a flat rate of 35% on incomes above $18,333,333.
According to the Los Angeles Times
there is Republican support for cutting down the top corporate tax from 35% to 25%.
Notes: The rates above are for regular corporate taxes based on income (including those called franchise taxes) and exclude the effect of alternative taxes and minimum taxes. Most states have a minimum income or franchise tax. The above rates generally apply to entities treated as corporations other than S Corporations and financial institutions, which may be subject to different rates of tax. Tax rates are before credits and reductions for corporations operating in certain parts of the state.
(a) Excludes the effect of graduated tax rates based on level of income.
(b) The Michigan Business Tax applies to incorporated and unincorporated businesses, and is based on alternative measure of income that may not relate to net income.
(c) Businesses with an entire net income greater than $100K pay 9% in all taxable income, companies with entire net income greater than $50K and less than or equal to $100K pay 7.5% on all taxable income, and companies with entire net income less than or equal to $50K pay 6.5% on all taxable income.
(d) A tax on gross receipts, the commercial activity tax (CAT), was phased in from 2005 to 2008 while the corporate franchise tax (CFT, Ohio's corporate net income tax) was phased out. Beginning April 1, 2009, the CAT rate was fully phased in at 0.26%.
(e) The top income tax rate (7.9% on income over $250K) applies to tax years beginning on or after January 1, 2009, and before January 1, 2011.
(f) Excludes local corporate income tax.
(g) Excludes the effect of alternative tax bases, such as sales or assets.
(h) Other tax rates may apply to certain corporations.
(i) Missouri allows a deduction for Federal income tax payments, reducing the effective state tax rate.
(j) A higher rate applies if the corporation elects "water's edge" apportionment.
(k) Also applies to unincorporated entities.
(l) While not called an income tax, Texas imposes a franchise tax at the higher of a tax based on capital or a graduated tax based on income.
. This credit is allowed to all taxpayers for income taxes paid to foreign countries. The credit is limited to that part of Federal income tax before other credits generated by foreign source taxable income. The credit is intended to mitigate taxation of the same income to the same taxpayer by two or more countries, and has been a feature of the U.S. system since 1918. Other credits include credits for certain wage payments, credits for investments in certain types of assets including certain motor vehicles, credits for use of alternative fuels and off-highway vehicle use, natural resource related credits, and others. See, e.g., the earned income credit, 26 USC 32.
is allowed at the Federal, state and local levels for interest expense incurred by a corporation in carrying out its business activities. Where such interest is paid to related parties, such deduction may be limited. The classification of instruments as debt on which interest is deductible or as equity with respect to which distributions are not deductible is highly complex and based on court-developed law. The courts have considered 26 factors in deciding whether an instrument is debt or equity, and no single factor predominates.
Federal tax rules also limit the deduction of interest expense paid by corporations to foreign shareholders based on a complex calculation designed to limit the deduction to 50% of cash flow. Some states have other limitations on related party payments of interest and royalties.
Example: John and Mary are United States residents who operate a business. They decide to incorporate for business reasons. They transfer assets of the business to Newco, a newly formed Delaware corporation of which they are the sole shareholders, subject to accrued liabilities of the business, solely in exchange for common shares of Newco. This transfer should not generally cause gain or loss recognition for John, Mary, or Newco. Newco assumes John and Mary's tax basis
in the assets it acquires. If on the other hand Newco also assumes a bank loan in excess of the basis of the assets transferred less the accrued liabilities, John and Mary will recognize taxable gain for such excess.
.
Dividends received by other corporations may be taxed at reduced rates, or exempt from taxation, if the dividends received deduction
applies. Dividends received by individuals (if the dividend is a "qualified dividend
") are taxed at reduced rates. Exceptions to shareholder taxation apply to certain nonroutine distributions, including distributions in liquidation of an 80% subsidiary or in complete termination of a shareholder's interest.
If a corporation makes a distribution in a non-cash form, it must pay tax on any gain in value of the property distributed.
The United States does not generally require withholding tax
on the payment of dividends to shareholders. However, withholding tax is required if the shareholder is not a US citizen or resident or US corporation, or in some other circumstances (see Tax withholding in the United States
).
, add-back of most tax exempt income, and deduction of many non-deductible expenses (e.g., 50% of meals and entertainment). Corporate distributions in excess of E&P are generally treated as a return of capital to the shareholders.
). This tax is imposed at the same rate as the tax on business income of a resident corporation.
The U.S. also imposes a branch profits tax on foreign corporations with a U.S. branch, to mimic the dividend withholding tax which would be payable if the business was conducted in a U.S. subsidiary corporation and profits were remitted to the foreign parent as dividends. The branch profits tax is imposed at the time profits are remitted or deemed remitted outside the U.S..
In addition, foreign corporations are subject to withholding tax
at 30% on dividends, interest, royalties, and certain other income. Tax treaties may reduce or eliminate this tax.
, adjustments related to costs of developing natural resources, and an addback of certain tax exempt interest.
Corporations may also be subject to additional taxes in certain circumstances. These include taxes on excess accumulated undistributed earnings and personal holding companies and restrictions on graduated rates for personal service corporations.
Some states, such as New Jersey, impose alternative taxes based on measures other than taxable income. Among such measures are gross income, pipeline revenues, gross receipts, and various asset or capital measures. In addition, some states impose a tax on capital of corporations or on shares issued and outstanding. The U. S. state of Michigan previously taxed businesses on an alternative base that did not allow compensation of employees as a tax deduction and allowed full deduction of the cost of production assets upon acquisition.
s, insurance companies, Domestic International Sales Corporations
, foreign corporations, and other entities. The structure of the forms and the imbedded schedules vary by type of form.
United States Federal corporate tax returns require both computation of taxable income from components thereof and reconciliation of taxable income to financial statement income. Corporations with assets exceeding $10 million must complete a detailed 3 page reconciliation on Schedule M-3 indicating which differences are permanent (i.e., do not reverse, such as disallowed expenses or tax exempt interest) and which are temporary (e.g., differences in when income or expense is recognized for book and tax purposes).
Some state corporate tax returns have significant imbedded or attached schedules related to features of the state's tax system that differ from the Federal system.
Preparation of non-simple corporate tax returns can be time consuming. For example, the U.S. Internal Revenue Service
states that the average time needed to complete Form 1120-S, for privately held companies electing flow through status, is over 56 hours, not including recordkeeping time.
Federal corporate tax returns for most types of corporations are due by the 15th day of the third month following the tax year (March 15 for calendar year). State corporate tax return due dates vary, but most are due either on the same date or one month after the Federal due date. Extensions of time to file are routinely granted.
Penalties may be imposed at the Federal and state levels for late filing or non-filing of corporate income tax returns. In addition, other substantial penalties may apply with respect to failures related to returns and tax return computations. Intentional failure to file or intentional filing of incorrect returns may result in criminal penalties to those involved.
Standard tax texts
Treatises
Taxable income
Taxable income refers to the base upon which an income tax system imposes tax. Generally, it includes some or all items of income and is reduced by expenses and other deductions. The amounts included as income, expenses, and other deductions vary by country or system. Many systems provide that...
vary from 15% to 35%. State and local taxes and rules vary by jurisdiction, though many are based on Federal concepts and definitions. Taxable income may differ from book income both as to timing of income and tax deductions and as to what is taxable. Corporations are also subject to a Federal Alternative Minimum Tax
Alternative Minimum Tax
The Alternative Minimum Tax is an income tax imposed by the United States federal government on individuals, corporations, estates, and trusts. AMT is imposed at a nearly flat rate on an adjusted amount of taxable income above a certain threshold . This exemption is substantially higher than the...
and alternative state taxes. Like individuals, corporations must file tax returns every year. They must make quarterly estimated tax payments. Controlled groups of corporations may file a consolidated return.
Some corporate transactions are not taxable. These include most formations and some types of mergers, acquisitions, and liquidations. Shareholders of a corporation are taxed on dividends distributed by the corporation. Corporations may be subject to foreign income taxes, and may be granted a foreign tax credit
Foreign tax credit
Income tax systems that tax residents on worldwide income generally offer a foreign tax credit to mitigate the potential for double taxation. The credit may also be granted in those systems taxing residents on income that may have been taxed in another jurisdiction...
for such taxes.
Shareholders of most corporations are not taxed directly on corporate income, but must pay tax on dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
s paid by the corporation. However, shareholders of S Corporations
S Corporation
An S corporation, for United States federal income tax purposes, is a corporation that makes a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code....
and mutual funds are taxed currently on corporate income, and do not pay tax on dividends.
Overview
Corporate income tax is imposed at the federal level on all entities treated as corporations (see Entity classification below), and by 47 states and the District of Columbia. Certain localities also impose corporate income tax. Corporate income tax is imposed on all domestic corporations and on foreign corporationForeign corporation
A foreign corporation is a term used in the United States for an existing corporation that is registered to do business in a state or other jurisdiction other than where it was originally incorporated...
s having income or activities within the jurisdiction. For Federal purposes, an entity treated as a corporation and organized under the laws of any state is a domestic corporation. For state purposes, entities organized in that state are treated as domestic, and entities organized outside that state are treated as foreign.
Some types of corporations (S corporation
S Corporation
An S corporation, for United States federal income tax purposes, is a corporation that makes a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code....
s, mutual funds, etc.) are not taxed at the corporate level, and their shareholders are taxed on the corporation's income as it is recognized. Corporations which are not S Corporations are known as C Corporation
C corporation
C corporation refers to any corporation that, under United States income tax law, is taxed separately from its owners. It is distinguished from an S corporation, which is not taxed separately. Most major companies are treated as C corporations for U.S. income tax purposes.-C corporation vs...
s.
Domestic corporations are taxed on their worldwide income at the Federal and state levels. Corporate income tax is based on net taxable income
Taxable income
Taxable income refers to the base upon which an income tax system imposes tax. Generally, it includes some or all items of income and is reduced by expenses and other deductions. The amounts included as income, expenses, and other deductions vary by country or system. Many systems provide that...
as defined under Federal or state law. Generally, taxable income for a corporation is gross income (business and possibly non-business receipts less cost of goods sold) less allowable tax deductions. Certain income, and some corporations, are subject to a tax exemption
Tax exemption
Various tax systems grant a tax exemption to certain organizations, persons, income, property or other items taxable under the system. Tax exemption may also refer to a personal allowance or specific monetary exemption which may be claimed by an individual to reduce taxable income under some...
. Also, tax deductions for interest and certain other expenses paid to related parties are subject to limitations.
Corporations may choose their tax year. Generally, a tax year must be 12 months or 52/53 weeks long. The tax year need not conform to the financial reporting year, and need not coincide with the calendar year, provided books are kept for the selected tax year. Corporations may change their tax year, which may require Internal Revenue Service
Internal Revenue Service
The Internal Revenue Service is the revenue service of the United States federal government. The agency is a bureau of the Department of the Treasury, and is under the immediate direction of the Commissioner of Internal Revenue...
consent. Most state income taxes are determined on the same tax year as the Federal tax year.
Federal corporate income tax is imposed at graduated rates. The lower rate brackets are phased out at higher rates of income. All taxable income is subject to tax at 34% or 35% where taxable income exceeds $335,000. Tax rates imposed below the federal level vary widely by jurisdiction, from under 1% to over 16%. State and local income taxes are allowed as tax deductions in computing Federal taxable income.
Groups of companies
Corporate group
A corporate group is a collection of parent and subsidiary corporations that function as a single economic entity through a common source of control. The concept of a group is frequently used in tax law, accounting and company law to attribute the rights and duties of one member of the group to...
are permitted to file single returns for the members of a controlled group or unitary group, known as consolidated returns
Tax consolidation
Tax consolidation is a regime adopted in the tax or revenue legislation of a number of countries which treats a group of wholly owned or majority-owned companies and other entities as a single entity for tax purposes...
, at the Federal level, and are allowed or required to do so by certain states. The consolidated return reports the members' combined taxable incomes and computes a combined tax. Where related parties do not file a consolidated return in a jurisdiction, they are subject to transfer pricing
Transfer pricing
Transfer pricing refers to the setting, analysis, documentation, and adjustment of charges made between related parties for goods, services, or use of property . Transfer prices among components of an enterprise may be used to reflect allocation of resources among such components, or for other...
rules. Under these rules, tax authorities may adjust prices charged between related parties.
Shareholders of corporations are taxed separately upon the distribution of corporate earnings and profits as a dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
. Tax rates on dividends are at present lower than on ordinary income for both corporate and individual shareholders. To insure that shareholders pay tax on dividends, two withholding tax provisions may apply: withholding tax
Withholding tax
Withholding tax, also called retention tax, is a government requirement for the payer of an item of income to withhold or deduct tax from the payment, and pay that tax to the government. In most jurisdictions, withholding tax applies to employment income. Many jurisdictions also require...
on foreign shareholders, and “backup withholding” on certain domestic shareholders.
Corporations must file tax returns in all U.S. jurisdictions imposing an income tax. Such returns are a self assessment of tax. Corporate income tax is payable in advance installments, or estimated payments, at the Federal level and for many states.
Corporations may be subject to withholding tax
Withholding tax
Withholding tax, also called retention tax, is a government requirement for the payer of an item of income to withhold or deduct tax from the payment, and pay that tax to the government. In most jurisdictions, withholding tax applies to employment income. Many jurisdictions also require...
obligations upon making certain varieties of payments to others, including wages and distributions treated as dividends. These obligations are generally not the tax of the corporation, but the system may impose penalties on the corporation or its officers or employees for failing to withhold and pay over such taxes.
State and local income taxes
Nearly all of the states and some localities impose a tax on corporation income. The rules for determining this tax vary widely from state to state. Many of the states compute taxable income with reference to Federal taxable income, with specific modifications. The states do not allow a tax deduction for income taxes, whether Federal or state. Further, most states deny tax exemption for interest income that is tax exempt at the Federal level.Most states tax domestic and foreign corporations on taxable income derived from business activities apportioned to the state on a formulary basis. Many states apply a "throw back" concept to tax domestic corporations on income not taxed by other states. Tax treaties do not apply to state taxes.
Under the U.S. constitution, states are prohibited from taxing income of a resident of another state unless the connection with the taxing state reach a certain level (called “nexus”). Most states do not tax non-business income of out of state corporations. Since the tax must be fairly apportioned, the states and localities compute income of out of state corporations (including those in foreign countries) taxable in the state by applying formulary apportionment
Formulary apportionment
In corporate taxation, formulary apportionment is a method of allocating the profit earned, or loss incurred, by a corporation or corporate group to a particular tax jurisdiction in which the corporation or group has a taxable presence...
to the total business taxable income of the corporation. Many states use a formula based on ratios of property, payroll, and sales within the state to those items outside the state.
History
The first Federal income tax was enacted in 1861, and expired in 1872, amid Constitutional challenges. A corporate income tax was enacted in 1894, but was shortly held unconstitutional. In 1909, Congress enacted an excise tax on corporations based on income. After ratification of the Sixteenth amendment to the U.S. Constitution, this became the corporate provisions of the Federal income tax. Amendments to various provisions affecting corporations have been in most or all revenue actsRevenue Act
-British Empire:*Revenue Act of 1764, popularly known as the Sugar Act*Revenue Act of 1766*Revenue Act of 1767 , one of the Townshend Acts-United States:* Revenue Act of 1861* Revenue Act of 1862...
since. Corporate tax provisions are incorporated in Title 26 of the United States Code
United States Code
The Code of Laws of the United States of America is a compilation and codification of the general and permanent federal laws of the United States...
, known as the Internal Revenue Code
Internal Revenue Code
The Internal Revenue Code is the domestic portion of Federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 of the United States Code...
. The present rate of tax on corporate income was adopted in the Tax Reform Act of 1986
Tax Reform Act of 1986
The U.S. Congress passed the Tax Reform Act of 1986 to simplify the income tax code, broaden the tax base and eliminate many tax shelters and other preferences...
.
Entity classification
Business entities may elect to be treated as corporations taxed at the entity and member levels or as “flow through” entities taxed only at the member level. However, entities organized as corporations under U.S. state laws and certain foreign entities are treated, per se, as corporations, with no optional election. The Internal Revenue ServiceInternal Revenue Service
The Internal Revenue Service is the revenue service of the United States federal government. The agency is a bureau of the Department of the Treasury, and is under the immediate direction of the Commissioner of Internal Revenue...
issued the so-called “check-the-box” regulations in 1997 under which entities may make such choice by filing Form 8832. Absent such election, default classifications for domestic and foreign business entities, combined with voluntary entity elections to opt out of the default classifications (except in the case of “per se corporations” (as defined below)). If an entity not treated as a corporation has more than one equity owner and at least one equity owner does not have limited liability (e.g. a general partner
General partner
General partner is a legal term used to describe a person who joins with at least one other person to form a business. A general partner has responsibility for the actions of the business, can legally bind the business and is personally liable for all the business's debts and obligations.General...
), it will be classified as a partnership (i.e. a pass-through), and if the entity has a single equity owner and the single owner does not have limited liability protection, it will be treated as a disregarded entity (i.e. a pass-through).
Some entities treated as corporations may make other elections that enable corporate income to be taxed only at the shareholder level, and not at the corporate level. Such entities are treated similarly to partnerships. The income of the entity is not taxed at the corporate level, and the members must pay tax on their share of the entity's income. These include:
- S CorporationsS CorporationAn S corporation, for United States federal income tax purposes, is a corporation that makes a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code....
, all of whose shareholders must be U.S. citizens or resident individuals; other restrictions apply. The election requires the consent of all shareholders. If a corporation is not an S corporation from its formation, special rules apply to the taxation of income earned (or gains accrued) before the election. - Regulated investment companies (RICs), commonly referred to as mutual funds.
- Real Estate Investment Trusts (REITs).
Taxable income
Determinations of what is taxable and at what rate are made at the Federal level based on U.S. tax law. Many but not all states incorporate Federal law principles in their tax laws to some extent. Federal taxable income equals gross incomeGross income
Gross income in United States tax law is receipts and gains from all sources less cost of goods sold. Gross income is the starting point for determining Federal and state income tax of individuals, corporations, estates and trusts, whether resident or nonresident."Except as otherwise provided" by...
(gross receipts and other income less cost of goods sold
Cost of goods sold
Cost of goods sold refers to the inventory costs of those goods a business has sold during a particular period. Costs are associated with particular goods using one of several formulas, including specific identification, first-in first-out , or average cost...
) less tax deductions. Gross income of a corporation and business deductions are determined in much the same manner as for individuals. All income of a corporation is subject to the same Federal tax rate. However, corporations may reduce other Federal taxable income by a net capital loss and certain deductions are more limited. Certain deductions are available only to corporations. These include deductions for dividends received and amortization of organization expenses. Some states tax business income of a corporation differently than nonbusiness income.
Principles for recognizing income and deductions may differ from financial accounting principles. Key areas of difference include differences in the timing of income or deduction, tax exemption
Tax exemption
Various tax systems grant a tax exemption to certain organizations, persons, income, property or other items taxable under the system. Tax exemption may also refer to a personal allowance or specific monetary exemption which may be claimed by an individual to reduce taxable income under some...
for certain income, and disallowance or limitation of certain tax deductions. IRS rules require that these differences be disclosed in considerable detail for non-small corporations on Schedule M-3 to Form 1120.
Federal tax rates
For regular income tax purposes, a system of graduated marginal tax rates is applied to all taxable income, including capital gains. Through 2010, the marginal tax rates on a corporation's taxable income are as follows:| Taxable Income ($) | Tax Rate |
|---|---|
| 0 to 50,000 | 15% |
| 50,000 to 75,000 | $7,500 + 25% Of the amount over 50,000 |
| 75,000 to 100,000 | $13,750 + 34% Of the amount over 75,000 |
| 100,000 to 335,000 | $22,250 + 39% Of the amount over 100,000 |
| 335,000 to 10,000,000 | $113,900 + 34% Of the amount over 335,000 |
| 10,000,000 to 15,000,000 | $3,400,000 + 35% Of the amount over 10,000,000 |
| 15,000,000 to 18,333,333 | $5,150,000 + 38% Of the amount over 15,000,000 |
| 18,333,333 and up | 35% |
This rate structure produces a flat 34% tax rate on incomes from $335,000 to $10,000,000, gradually increasing to a flat rate of 35% on incomes above $18,333,333.
According to the Los Angeles Times
Los Angeles Times
The Los Angeles Times is a daily newspaper published in Los Angeles, California, since 1881. It was the second-largest metropolitan newspaper in circulation in the United States in 2008 and the fourth most widely distributed newspaper in the country....
there is Republican support for cutting down the top corporate tax from 35% to 25%.
State income tax rates
The table lists the tax rates on corporate income applied by each state, but not by local governments within states. Because state and local taxes are deductible expenses for federal income tax purposes, the effective tax rate in each state is not a simple addition of federal and state tax rates.| State | Tax Rate(s) | Tax Bracket(s) |
|---|---|---|
| $0 | ||
| $0 | ||
| $0 | ||
| $0 | ||
| $0 | ||
| $0 | ||
| $0 | ||
Notes: The rates above are for regular corporate taxes based on income (including those called franchise taxes) and exclude the effect of alternative taxes and minimum taxes. Most states have a minimum income or franchise tax. The above rates generally apply to entities treated as corporations other than S Corporations and financial institutions, which may be subject to different rates of tax. Tax rates are before credits and reductions for corporations operating in certain parts of the state.
(a) Excludes the effect of graduated tax rates based on level of income.
(b) The Michigan Business Tax applies to incorporated and unincorporated businesses, and is based on alternative measure of income that may not relate to net income.
(c) Businesses with an entire net income greater than $100K pay 9% in all taxable income, companies with entire net income greater than $50K and less than or equal to $100K pay 7.5% on all taxable income, and companies with entire net income less than or equal to $50K pay 6.5% on all taxable income.
(d) A tax on gross receipts, the commercial activity tax (CAT), was phased in from 2005 to 2008 while the corporate franchise tax (CFT, Ohio's corporate net income tax) was phased out. Beginning April 1, 2009, the CAT rate was fully phased in at 0.26%.
(e) The top income tax rate (7.9% on income over $250K) applies to tax years beginning on or after January 1, 2009, and before January 1, 2011.
(f) Excludes local corporate income tax.
(g) Excludes the effect of alternative tax bases, such as sales or assets.
(h) Other tax rates may apply to certain corporations.
(i) Missouri allows a deduction for Federal income tax payments, reducing the effective state tax rate.
(j) A higher rate applies if the corporation elects "water's edge" apportionment.
(k) Also applies to unincorporated entities.
(l) While not called an income tax, Texas imposes a franchise tax at the higher of a tax based on capital or a graduated tax based on income.
Tax credits
Corporations, like other businesses, may be eligible for various tax credits which reduce Federal, state or local income tax. The largest of these by dollar volume is the Federal foreign tax creditForeign tax credit
Income tax systems that tax residents on worldwide income generally offer a foreign tax credit to mitigate the potential for double taxation. The credit may also be granted in those systems taxing residents on income that may have been taxed in another jurisdiction...
. This credit is allowed to all taxpayers for income taxes paid to foreign countries. The credit is limited to that part of Federal income tax before other credits generated by foreign source taxable income. The credit is intended to mitigate taxation of the same income to the same taxpayer by two or more countries, and has been a feature of the U.S. system since 1918. Other credits include credits for certain wage payments, credits for investments in certain types of assets including certain motor vehicles, credits for use of alternative fuels and off-highway vehicle use, natural resource related credits, and others. See, e.g., the earned income credit, 26 USC 32.
Interest deduction limitations
A tax deductionTax deduction
Income tax systems generally allow a tax deduction, i.e., a reduction of the income subject to tax, for various items, especially expenses incurred to produce income. Often these deductions are subject to limitations or conditions...
is allowed at the Federal, state and local levels for interest expense incurred by a corporation in carrying out its business activities. Where such interest is paid to related parties, such deduction may be limited. The classification of instruments as debt on which interest is deductible or as equity with respect to which distributions are not deductible is highly complex and based on court-developed law. The courts have considered 26 factors in deciding whether an instrument is debt or equity, and no single factor predominates.
Federal tax rules also limit the deduction of interest expense paid by corporations to foreign shareholders based on a complex calculation designed to limit the deduction to 50% of cash flow. Some states have other limitations on related party payments of interest and royalties.
Other corporate events
U.S. rules provide that certain corporate events are not taxable to corporations or shareholders. Significant restrictions and special rules often apply. The rules related to such transactions are quite complex, and exist primarily at the Federal level. Many of the states follow Federal tax treatment for such events.Formation
The formation of a corporation by controlling corporate or non-corporate shareholder(s) is generally a nontaxable event. Generally, in tax free formations the tax attributes of assets and liabilities are transferred to the new corporation along with such assets and liabilities.Example: John and Mary are United States residents who operate a business. They decide to incorporate for business reasons. They transfer assets of the business to Newco, a newly formed Delaware corporation of which they are the sole shareholders, subject to accrued liabilities of the business, solely in exchange for common shares of Newco. This transfer should not generally cause gain or loss recognition for John, Mary, or Newco. Newco assumes John and Mary's tax basis
Tax basis
The tax basis of an asset is generally its cost. Determining such cost may require allocations where multiple assets are acquired together. Tax basis may be reduced by allowances for depreciation. Such reduced basis is referred to as the adjusted tax basis. Adjusted tax basis is used in...
in the assets it acquires. If on the other hand Newco also assumes a bank loan in excess of the basis of the assets transferred less the accrued liabilities, John and Mary will recognize taxable gain for such excess.
Acquisitions
Corporations may merge or acquire other corporations in a manner treated as nontaxable to either of the corporations and/or to their shareholders. Generally, significant restrictions apply if tax free treatment is to be obtained. For example, Bigco acquires all of the shares of Smallco from Smallco shareholders in exchange solely for Bigco shares. This acquisition is not taxable to Smallco or its shareholders under U.S. tax law if certain requirements are met, even if Smallco is then liquidated into or merged with Bigco.Reorganizations
In addition, corporations may change key aspects of their legal identity, capitalization, or structure in a tax free manner. Examples of reorganizations that may be tax free include mergers, liquidations of subsidiaries, share for share exchanges, exchanges of shares for assets, changes in form or place of organization, and recapitalizations.Distribution of earnings
Shareholders of corporations are subject to corporate or individual income tax when corporate earnings are distributed. Such distribution of earnings is generally referred to as a dividendDividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
.
Dividends received by other corporations may be taxed at reduced rates, or exempt from taxation, if the dividends received deduction
Dividends received deduction
The dividends-received deduction , under U.S. federal income tax law, is a tax deduction received by a corporation on the dividends paid to it by other corporations in which it has an ownership stake.-Impact:...
applies. Dividends received by individuals (if the dividend is a "qualified dividend
Qualified dividend
Qualified dividends, as defined by the United States Internal Revenue Code, are ordinary dividends that meet specific criteria to be taxed at the lower long-term capital gains tax rate rather than at higher tax rate for an individual's ordinary income...
") are taxed at reduced rates. Exceptions to shareholder taxation apply to certain nonroutine distributions, including distributions in liquidation of an 80% subsidiary or in complete termination of a shareholder's interest.
If a corporation makes a distribution in a non-cash form, it must pay tax on any gain in value of the property distributed.
The United States does not generally require withholding tax
Withholding tax
Withholding tax, also called retention tax, is a government requirement for the payer of an item of income to withhold or deduct tax from the payment, and pay that tax to the government. In most jurisdictions, withholding tax applies to employment income. Many jurisdictions also require...
on the payment of dividends to shareholders. However, withholding tax is required if the shareholder is not a US citizen or resident or US corporation, or in some other circumstances (see Tax withholding in the United States
Tax withholding in the United States
Three key types of withholding tax are imposed at various levels in the United States:*Wage withholding taxes,*Withholding tax on payments to foreign persons, and*Backup withholding on dividends and interest....
).
Earnings and profits
U.S. corporations are permitted to distribute amounts in excess of earnings under the laws of most states under which they may be organized. A distribution by a corporation to shareholders is treated as a dividend to the extent of earnings and profits (E&P), a tax concept similar to retained earnings. E&P is current taxable income, with significant adjustments, plus prior E&P reduced by distributions of E&P. Adjustments include depreciation differences under MACRSMACRS
The Modified Accelerated Cost Recovery System is the current tax depreciation system in the United States. Under this system, the capitalized cost of tangible property is recovered over a specified life by annual deductions for depreciation. The lives are specified broadly in the Internal...
, add-back of most tax exempt income, and deduction of many non-deductible expenses (e.g., 50% of meals and entertainment). Corporate distributions in excess of E&P are generally treated as a return of capital to the shareholders.
Foreign corporation branches
The United States taxes foreign (i.e., non-U.S.) corporations differently than domestic corporations. Foreign corporations generally are taxed only on business income when the income is effectively connected with the conduct of a U.S. trade or business (i.e. in a branchPermanent establishment
A permanent establishment is a fixed place of business which generally gives rise to income or value added tax liability in a particular jurisdiction. The term is defined in many income tax treaties and most European Union Value Added Tax systems. The tax systems in some civil law countries...
). This tax is imposed at the same rate as the tax on business income of a resident corporation.
The U.S. also imposes a branch profits tax on foreign corporations with a U.S. branch, to mimic the dividend withholding tax which would be payable if the business was conducted in a U.S. subsidiary corporation and profits were remitted to the foreign parent as dividends. The branch profits tax is imposed at the time profits are remitted or deemed remitted outside the U.S..
In addition, foreign corporations are subject to withholding tax
Tax withholding in the United States
Three key types of withholding tax are imposed at various levels in the United States:*Wage withholding taxes,*Withholding tax on payments to foreign persons, and*Backup withholding on dividends and interest....
at 30% on dividends, interest, royalties, and certain other income. Tax treaties may reduce or eliminate this tax.
Consolidated returns
Corporations 80% or more owned by a common parent corporation may file a consolidated return for Federal and some state income taxes. These returns include all income, deductions, and credits of all members of the controlled group, generally expressed without intercompany eliminations. Some states allow or require a combined or consolidated return for U.S. members of a "unitary" group under common control and in related businesses. Certain transactions between group members may not be recognized until the occurrence of events for other members. For example, if Company A sells goods to sister Company B, the profit on the sale is deferred until Company B uses or sells the goods. All members of a consolidated group must use the same tax year.Transfer pricing
Transactions between a corporation and related parties are subject to potential adjustment by tax authorities. These adjustments may be applied to both U.S. and foreign related parties, and to individuals, corporations, partnerships, estates, and trusts.Alternative taxes
United States federal income tax incorporates an alternative minimum tax. This tax is computed at a lower tax rate (20% for corporations), and imposed based on a modified version of taxable income. Modifications include longer depreciation lives assets under MACRSMACRS
The Modified Accelerated Cost Recovery System is the current tax depreciation system in the United States. Under this system, the capitalized cost of tangible property is recovered over a specified life by annual deductions for depreciation. The lives are specified broadly in the Internal...
, adjustments related to costs of developing natural resources, and an addback of certain tax exempt interest.
Corporations may also be subject to additional taxes in certain circumstances. These include taxes on excess accumulated undistributed earnings and personal holding companies and restrictions on graduated rates for personal service corporations.
Some states, such as New Jersey, impose alternative taxes based on measures other than taxable income. Among such measures are gross income, pipeline revenues, gross receipts, and various asset or capital measures. In addition, some states impose a tax on capital of corporations or on shares issued and outstanding. The U. S. state of Michigan previously taxed businesses on an alternative base that did not allow compensation of employees as a tax deduction and allowed full deduction of the cost of production assets upon acquisition.
Tax returns
Corporations subject to U.S. tax must file Federal and state income tax returns. Different tax returns are required at the Federal and some state levels for different types of corporations or corporations engaged in specialized businesses. The United States has 13 variations on the basic Form 1120 for S corporationS Corporation
An S corporation, for United States federal income tax purposes, is a corporation that makes a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code....
s, insurance companies, Domestic International Sales Corporations
Domestic international sales corporation
This is a provision unique to U.S. tax law. In 1971, the U.S. Congress voted to subsidize exports of U.S. made goods through the income tax law. The initial mechanism was through a Domestic International Sales Corporation , an entity with no substance which received tax benefits...
, foreign corporations, and other entities. The structure of the forms and the imbedded schedules vary by type of form.
United States Federal corporate tax returns require both computation of taxable income from components thereof and reconciliation of taxable income to financial statement income. Corporations with assets exceeding $10 million must complete a detailed 3 page reconciliation on Schedule M-3 indicating which differences are permanent (i.e., do not reverse, such as disallowed expenses or tax exempt interest) and which are temporary (e.g., differences in when income or expense is recognized for book and tax purposes).
Some state corporate tax returns have significant imbedded or attached schedules related to features of the state's tax system that differ from the Federal system.
Preparation of non-simple corporate tax returns can be time consuming. For example, the U.S. Internal Revenue Service
Internal Revenue Service
The Internal Revenue Service is the revenue service of the United States federal government. The agency is a bureau of the Department of the Treasury, and is under the immediate direction of the Commissioner of Internal Revenue...
states that the average time needed to complete Form 1120-S, for privately held companies electing flow through status, is over 56 hours, not including recordkeeping time.
Federal corporate tax returns for most types of corporations are due by the 15th day of the third month following the tax year (March 15 for calendar year). State corporate tax return due dates vary, but most are due either on the same date or one month after the Federal due date. Extensions of time to file are routinely granted.
Penalties may be imposed at the Federal and state levels for late filing or non-filing of corporate income tax returns. In addition, other substantial penalties may apply with respect to failures related to returns and tax return computations. Intentional failure to file or intentional filing of incorrect returns may result in criminal penalties to those involved.
Further reading
IRS Publication 542, CorporationsStandard tax texts
- Willis, Eugene; Hoffman, William H. Jr., et al: South-Western Federal Taxation, published annually. 2009 edition (cited above as Willis|Hoffman 2009) included in ISBN 973-0-324-66060-0 (student) and ISBN 978-0-324-66208-5 (instructor).
- Pratt, James W.; Kulsrud, William N., et al: Federal Taxation, updated periodically. 2010 edition ISBN 978-1424069866 (2005 edition ISBN 0-759-34175-9 cited above as Pratt & Kulsrud 2005).
Treatises
- Bittker, Boris I. and Eustice, James S.: Federal Income Taxation of Corporations and Shareholders: abridged paperback ISBN 978-0-7913-4101-8 or as a subscription service. Cited above as Bittker & Eustice.
- Crestol, Jack; Hennessey, Kevin M.; and Yates, Richard F.: "Consolidated Tax Return : Principles, Practice, Planning, 1998 ISBN 978-0-7913-1629-0
- Kahn & Lehman. Corporate Income Taxation
- Healy, John C. and Schadewald, Michael S.: Multistate Corporate Tax Course 2010, CCH, ISBN 978-0-8080-2173-5 (also available as a multi-volume guide, ISBN 978-0-8080-2015-8)
- Hoffman, et al.: Corporations, Partnerships, Estates and Trusts, ISBN 978-0-324-66021-0
- Momburn, et al.: Mastering Corporate Tax, Carolina Academic Press, ISBN 978-1-59460-368-6