Investment Glossary – Corporate Tax Rate
Just like individuals have to pay those pesky taxes each year on the income they earn, corporations have to pay taxes every year on the income they earn as well. In the United States, there is a separate corporate tax code that dictates the rates of taxation on that income, as well as the rules for what types of business expenses can be deducted to offset that income. Unlike the personal tax code, which has different income tax brackets for individuals, the corporate tax code is currently more straightforward when it comes to the rate of taxation. It has one bracket, and the corporate tax rate for that bracket is 21 percent. Unfortunately, even though it looks simple, figuring out how much tax your company owes isn’t necessarily as easy as it seems.
One of the key reasons for this is that this corporate tax rate does not apply to all companies. Why is that the case? Not every company is organized in the same fashion, and only one type of corporate structure, the C-corp, actually falls under the corporate tax code. Other corporate structures, such as Limited Liability Companies (LLCs), S-corps, and sole proprietorships all feature what is called pass-through income, which flows through to an individual’s personal tax return and is taxed as personal income, rather than at the corporate level. In some cases, this can be beneficial to an individual. One such example would be a company that earns relatively little profit, and thus would end up being taxed at either the 10 or 12 percent tax brackets if the income flowed through to the individual’s tax return, rather than 21 percent for the corporation. Pass-through entities may have some limitations as far as taking on new investors and flexibility for corporate structures, so this tends to offset these benefits and make the C-corp structure more attractive as a company grows.
But even for those entities, it’s no longer as simple as passing through all the income, though businesses that are set up using those structures do receive a lovely benefit as a result of changes to the tax code that became effective in 2018.
Under the new tax law, LLCs, S-corps, and sole proprietorships are able to deduct up to 20 percent of the net income they receive from the company, though there are some exclusions based on the type of industry the company operates in and its overall net income. This is one area where talking to a qualified tax professional makes a lot of sense, as the implementation of this change has been filled with questions, so it is a worthwhile endeavor to speak with someone who specializes in these types of filings.
Just like an individual has to either have taxes withheld from their paycheck or pay estimated taxes on a quarterly basis in order to keep up with their tax owed to the government, corporations have to pay estimated taxes as well, on the same schedule as individual filers. This means that if you operate a C-corp, you will likely be filing estimated taxes by April 15, June 15, September 15, and December 15, as long as your fiscal year matches up with the calendar year.
One final item to keep in mind is that the corporate tax rate only applies to net income that is earned by the corporation. If you are someone who owns a C-corp but also takes a salary and collects dividends from the corporation, that income is taxed separately to you at the appropriate rates, rather than at the corporate rate. The key idea here is to separate the income that is earned by the corporation as a whole from income that you receive from the corporation. Following that basic rule of thumb tends to make the applicable tax rate clear in most cases.