C Corporation Taxes

A C corporation (also known as a regular corporation) is considered a separate person or "entity" under the tax law and is taxed accordingly. Income earned by a corporation is normally taxed at the corporate level using the corporate income tax rates shown in the table below, and the corporation must file a Form 1120 each year to report this income.

After the corporate income tax is paid on the business income, any distributions made to stockholders are taxed again at the stockholders' tax rates as dividends. Because of these two levels of tax, a regular corporation may be a less desirable form of business than the other types of business entities (sole proprietorships, partnerships, limited liability companies, or S corporations). However, corporations do have many tax breaks not available to other forms of business. Incorporation should not be dismissed out of hand for fear of double taxation.

Comparison with partnerships or sole proprietorships. Because the taxation of income to sole proprietorships and partnerships is determined by the tax bracket that applies to each individual owner, a comparison of tax rates that apply to corporations and to individuals can give you some idea of which form of business would save taxes at a particular income level.

The 39.6 percent tax bracket means that the top individual rate is significantly higher than the top corporate tax rate. In addition, high-income taxpayers may be subject to the additional Medicare tax and the net investment income tax.

The following chart compares the marginal tax rates for tax years beginning in 2014 for corporations, married individuals filing jointly, and for singles. This chart does not include the additional Medicare tax or net investment income tax that may apply to high-income taxpayers.

The following chart compares the marginal tax rates for tax years beginning in 2015 for corporations, married individuals filing jointly, and for singles. This chart does not include the additional Medicare tax or net investment income tax that may apply to high-income taxpayers.

Keep in mind that the rate comparison is only part of the tax picture to consider. Distributions (money taken out) from a partnership are generally taxable only once on the partners' individual returns, while distributions made by a corporation to its shareholders after corporate tax is paid are taxed again as dividends on the shareholder's returns.

Salaries may offset corporate income tax. In comparing the tax advantages of operating as a partnership or sole proprietorship rather than as a corporation, remember that not all of the corporate income will be subject to double taxation. The operators of the corporation may be paid reasonable salaries, which are deductible by the corporation. These salaries are, therefore, free from tax at the corporate level (though the recipients will have to pay income tax, and both recipients and the business will have to pay FICA tax, on them). In some cases, the entire net profit may be offset by salaries paid to the owners, so that no corporate income tax is due.

Warning If your corporation is profitable but does not pay any dividends for an extended period of time, the IRS is likely to conclude that some of the salaries paid to owners are really disguised dividends. The IRS can disallow some or all of the salary deductions, resulting in a large tax bill plus interest and penalties. If you have a corporation, your best bet is to make sure all salaries are not significantly higher than industry standards, and to pay out at least some dividends each year.

Accumulated earnings tax. Because a corporation is a taxable entity that is separate from its stockholders, its excess profits (profits remaining after being taxed at the corporate level) are not, as in the case of unincorporated businesses and S corporations, taxed to the owners when they are earned. The profits are taxed only if and when they are distributed to the stockholders as dividends. However, a corporation may not safely accumulate (retain) its earnings indefinitely. If the accumulations are not related to the reasonable needs of the business, an accumulated earnings tax of 20 percent may be imposed in addition to the regular corporate tax. Virtually any corporation can accumulate up to $250,000 ($150,000 for professional service corporations) in retained earnings without becoming subject to this tax.

Transactions between corporations and owners. Transactions between a closely held corporation and its stockholder-owners will be closely examined by IRS agents. If corporate property is diverted to the stockholders, they will be considered to have received what is called a "constructive" or "preferential" dividend. This tax treatment is highly unfavorable, since this dividend will be taxable to the owners and will not be deductible to the corporation.

The most common type of preferential dividend received by stockholders involves the payment of personal expenses on behalf of stockholders. Typically, the corporation claims deductions for these expenses as business expenses on its income tax return, but where the expenses are clearly personal expenses, the corporation will be denied a deduction and the officer-stockholder will be deemed to have received a taxable dividend.

Stockholders are also considered to have received constructive dividends when: (1) corporate property is sold to a stockholder at less than its fair market value, (2) employee-stockholders are given unreasonably high compensation, (3) the corporation pays excess rents to shareholders for property leased by the corporation, or (4) the corporation loans the shareholder funds and there is no intention to repay the loan.

Corporate alternative minimum tax. Like individuals, corporations can become subject to an alternative minimum tax (AMT) if they have gained the benefit of "too many" tax preference items. The corporate AMT does not apply to a corporation that has averaged less than $7.5 million in annual gross receipts during the three-year period leading up to the current tax year ($5 million for the first three years of the corporation's existence). A corporation is exempt from the AMT in its first year of existence. For corporations that are subject to the AMT, the rate is 20 percent.

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