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What is a Corporation
By cpa | March 12, 2008
A C-corporation is also referred to as a standard corporation. It was the first type of business structure that was designed specifically to limit liability. A corporation is a separate and distinct legal entity. A corporation can open a bank account, own property and do business, all under its own name. The primary advantage of a corporation is that its shareholders are not personally liable for the debts and liabilities of the corporation. For example, if a corporation gets sued and is forced into bankruptcy, the owners will not be required to pay the debt with their own money. If the assets of the corporation are not enough to cover the debts, the creditors cannot go after the stockholders, directors or officers of the corporation to recover any shortfall, with some exceptions.
C-Corporation Taxes
A corporation files and pays income taxes as a separate entity under the tax laws. 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. Together, these two levels of taxes are referred to as “double taxation”. The major disadvantage of a traditional C-Corporation is double taxation. “C-corporation,” pays a corporate tax on its income (the first tax). Then, when the C-corporation distributes profits to its stockholders, the stockholders pay income tax on those dividends (the second tax).
Double Taxation Solution
For many small closely held businesses, double taxation may not be that big of an issue. As a matter of fact, most small businesses see it as a problem.
1. Zeroing Out.
For a small corporation, the shareholders are likely to be employees of the firm. The corporation often distributes earnings to employees as wages and fringe benefits. The corporation is able to deduct the wages and benefits paid to employees as a business expense, and thus is not required to pay corporate taxes on that amount, so there is not much left over to be subject to corporate taxes. the way to zero out the profit. A machinery corporation has a profit of $75,000. If this amount is paid to one or more of the officers of the corporation as compensation for services, the corporation will get a tax deduction for this $75,000 in bonus or salary. That will reduce taxable income to zero, and no federal income taxes would be due. However, the $75,000 is subject to self-employment tax and is included in the recipient’s income. This eliminates the problem of double taxation.
In cases where income is left in the business, it is often retained in order to finance future growth. Although this amount is subject to corporate taxes, many corporations never declare dividends, so for these corporations there are no dividends to be taxed twice. Even if there is a dividend, the consequences aren’t always financially earth shattering.
2. Reduced Dividend Tax Rate.
If the corporation declares the dividend, the individual income tax rates on dividends are reduced to 15% now (5% if the taxpayer is in the 10% or 15% income tax bracket). The shareholders are only tax at the reduced rate instead of the ordinary tax rate.
3. S-Corporation.
Another way to avoid double taxation is to make a special S election to be taxed as a pass-through entity. That way, there is only one level of taxation. The corporate profits “pass through” to the owners, who pay taxes on the profits at their individual tax rates. Corporations that make this tax election are known as “S-corporations”.
Topics: INCORPORATE |