What is Corporate Tax?
Corporate tax refers to the amount charged by the government on a company’s profits or net income. It is an essential source of revenue for the government. It is also known as corporation tax.
Corporation tax is calculated as per the specific norms of a country. Firms’ taxable incomes comprise profits from the sale of goods or services, commissions, interests, capital gains, and rents. To obtain the applicable taxable income, allowed deductions and exemptions are deducted from the profits.
Table of contents
- Corporation tax is the charges levied by a government on the taxable income of registered private or public corporations.
- Governments revise corporation tax rates every year to boost the nation’s overall economic growth.
- According to The Internal Revenue Service (IRS), C corporations are required to report business returns by filing Form 1120. However, a pass-through taxation entity or S corporation is required to file Form 1120-S— to avoid double taxation.
Corporate Tax Explained
A corporation is a separate legal entity that holds independent liabilitiesLiabilitiesLiability is a financial obligation as a result of any past event which is a legal binding. Settling of a liability requires an outflow of an economic resource mostly money, and these are shown in the balance of the company.. It earns profit from different sources such as sales revenue, capital gains, commissions, interests, and dividends. The government charges a corporation tax on the profits.
The United States currently levies a flat 21% corporation tax on the Taxable Income of the registered companies. In 2017, the US corporation tax rate was reduced from 35% to 21%. On average, corporations pay 25.89% for local, state, and federal taxes.
It is an essential source of revenue for the government. The corporation tax rate undergoes annual revisions around the globe. The amendments prioritize the growth of corporations and the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.. It is often lowered to allow expenditure on business development and capital enhancement. It is important to note that corporation tax is different from income tax charged on an individual’s personal earnings.
A “C corporationC CorporationAccording to US tax laws, any corporation that is not a S corporation is considered a C corporation, which has a different legal status and is taxed accordingly. It has its own articles of incorporation that defines its activities and is held by the shareholders, while its liability is limited.” has to report corporate returns by filing Form 1120. However, if a company files its returns using Form 1120-S, it is an “S corporationS CorporationS corporation refers to the special status entity exempted from paying corporate tax, which allows shareholders to be taxed only once when they receive the benefits by follow-through taxation, thereby avoiding double taxation at the corporate level under a special chapter of IRS so that all the rules specified in the chapter shall be complied with..” S corporations are pass-through taxation entities. These corporations do not pay any tax. Instead, the profits and losses are passed onto owners’ personal tax returns. The firms’ taxes are paid at an individual level by the owners.
For determining the corporation tax, the company’s taxable income has to be ascertained. Consequently, the following formula is used to compute the corporate tax amount:
The Adjusted Gross IncomeAdjusted Gross IncomeAdjusted Gross Income (AGI) is calculated from the gross income. It represents the net income earned by an individual in a year, including wages, capital gains, and retirement distributions after deducting above-the-line deductions. It determines an individual's taxable income by determining deductions or credits a person is eligible to receive. (AGI) can be obtained by deducting the applicable adjustments from gross income. The Gross IncomeGross IncomeThe difference between revenue and cost of goods sold is gross income, which is a profit margin made by a corporation from its operating activities. It is the amount of money an entity makes before paying non-operating expenses like interest, rent, and electricity. is the total income arising from goods sales, commissions, interests, rent, and other sources. The applicable adjustments include early withdrawal penalties, employee expenses, operation expenses, and other business expenses.
The Internal Revenue Service (IRS) allows itemized deductionsItemized DeductionsAn itemized deduction is an eligible expenditure incurred by the individual taxpayers on various products or services for claiming these expenditures on FIT (federal income tax) returns solely to reduce their tax implications. These are multiple sorts of tax-deductible expenditures incurred throughout the year., but if the taxpayer does not claim that, the standard deduction will be applied.
Corporate Tax Calculation
Now, let us go through the basic steps involved in the calculation of the corporate tax:
- First, find the adjusted gross income and the allowed deductions to compute the taxable income.
- Evaluate the corporation’s taxable income using this formula: Taxable income = Adjusted Gross Income – All Applicable Deductions.
- Multiply the corporation tax percentage with the taxable income to determine the corporation tax liability: Corporate Tax=Taxable Income × Corporate Tax Rate.
XYZ Corporation has earned a net profit of $50,000 during the current financial year. The company is allowed up to $5000 in deductions. The applicable corporation tax rate is 21%. Now, calculate the corporation tax liability.
Corporate Tax = Taxable Income × Corporate Tax Rate
Taxable Income = Adjusted Gross Income – All Applicable Deductions
Taxable Income = 50000 – 5000 = $45000
Corporate Tax = 45000 × 21% = $9450
Thus, XYZ Corporation is liable to pay $9450 as corporation tax.
Corporate Tax Planning
Firms can legitimately reduce the taxable income by utilizing tax planningTax PlanningTax planning is the process of minimizing the tax liability by making the best use of all available deductions, allowances, rebates, thresholds, and so on as permitted by income tax laws and rules imposed by a country's government. It contributes to better cash flow and liquidity management for taxpayers, as well as better retirement plans and investment opportunities. alternatives—not to be confused with unethical means—non-payment or tax evasionTax EvasionTax Evasion is an illegal act in which the taxpayers deliberately misreport their financial affairs to reduce or evade the actual tax liability. This includes using multiple financial ledgers, hiding or representing lesser income, gains, or profits than actually earned, overstating deductions, & failing to file returns. . By planning ahead, firms can avoid paying excessive taxes.
Tax consultants and chartered accountants decrease tax liability by using various deductions, credits, government subsidies, and exemptions approved by the Internal Revenue Service (IRS). These professionals have an in-depth knowledge of tax regulations, tax management, and tax planning.
We all have heard the cliché, “when businesses flourish, the nation’s economy grows.” But how does this work exactly? The answer is corporation tax.
Some of its other benefits are discussed below:
- Unbiased: The corporation tax is levied on all the registered corporations equitably, whether it is a public company or a private company.
- Source of Government Revenue: The government acquires enormous revenue through corporation taxes. The government relies on the collected revenue to fund public services like infrastructureInfrastructureInfrastructure refers to fundamental physical and technological frameworks that a region or industry establishes for its economy to function properly., defense, and transportation.
- Tax Deductions: Companies can seek tax deductions on employee medical insurance, employee wages, and other employee expenses. Bad debtsBad DebtsBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation. and losses can also be deducted from the taxable amount.
- Efficient Corporate Tax Planning: With proper tax planning, corporations can ethically reduce tax liabilities.
- Tax Incentives: Many developing economies offer tax-related incentives to encourage investments. A special economic zone (SEZ)Special Economic Zone (SEZ)Special economic zone (SEZ) refers to a particular region with specified boundaries providing competitive infrastructure and tailored laws to attract foreign direct investment into the nation. refers to a particular region with specified boundaries providing competitive infrastructure and tailored laws to attract foreign direct investmentForeign Direct InvestmentA foreign direct investment (FDI) is made by an individual or an organization, into a business located in a foreign country. The host nation receives job creation prospects, advanced technology, a higher standard of living, infrastructural development, and overall economic growth. into the nation.
According to the Internal Revenue Service (IRS), the following expenses can be deducted from taxable incomeTaxable IncomeThe taxable income formula calculates the total income taxable under the income tax. It differs based on whether you are calculating the taxable income for an individual or a business corporation.:
- Business losses;
- All ordinary and necessary corporate expenditures;
- Business expenses for bookkeepingBookkeepingBookkeeping is the day-to-day documentation of a company’s financial transactions. These transactions include purchases, sales, receipts, and payments., tax preparation, legal charges, advertising, and travel;
- Employee expenses—salary, health insurance, bonus, and tuition reimbursements;
- Insurance premiums, interest payments, bad debts, excise tax, sales taxSales TaxThe government levies sales tax on the consumption of various goods and services as the percentage added to the product and services from which the government earns revenue and does the company's welfare. In the United States, 38 different states have different taxes, from Alaska (1.76%) to Tennessee (9.45%)., and fuel tax.
Frequently Asked Questions (FAQs)
Corporation tax planning is the process of curtailing taxable income in an ethical manner. This is achieved by considering various allowable deductions and exemptions in accordance with the IRS. Chartered accountants facilitate tax planning. They suggest multiple ways of reducing liability compliant to regulations.
The corporation tax is a form of direct tax applied to a firm’s taxable income. The registered company must file IRS Form 1120 to report corporate tax returns. Consequently, the corporation has to pay the due corporation tax every quarter. The payment has to commence before the 15th.
Every registered company, both private and public, has to pay the corporation tax. However, the responsibility falls on shareholders—a portion of their profits are used to clear tax liabilities.
This has been a guide to what is Corporate Tax and its Meaning. Here we discuss corporate tax formula, calculation, examples, planning, and advantages. You can learn more from the following articles –