How Business Income Is Taxed
How your business is organized affects how its profits are taxed — as well as the tax-reducing strategies that may prove useful for you and any other owners. You’ll want to review the various forms of business as part of a comprehensive income-tax plan. Although non-tax considerations are critical in choosing a form of business, tax matters also play a role.
A regular “C” corporation pays federal income tax at the rates shown in the accompanying table and also could be subject to the corporate alternative minimum tax.
Corporate Tax Rates
| Taxable Income | Rate |
|---|---|
| Up to $50,000 | 15% |
| $50,001 – $75,000 | 25% |
| $75,001 – $100,000 | 34% |
| $100,001 – $335,000 |
39% |
| $335,001 – $10 million |
34% |
| Over $10 million – $15 million | 35% |
| Over $15 million – $18,333,333 | 38% |
| Over $18,333,333 | 35% |
| Alternative Minimum Tax | 20% |
|---|---|
| The corporate AMT exemption of $40,000 is phased out with alternative minimum taxable income between $150,000 and $310,000. | |
Dividend distributions paid to shareholders from corporate earnings and profits are not tax deductible and must be reported as income by the shareholders. Essentially, corporate income paid out as a dividend is taxed two times — once to the corporation and again to the shareholders. By paying shareholders who are employed by the firm reasonable salaries and bonuses on a tax-deductible basis, a corporation can lessen the impact of double taxation.
If you are an owner of a closely held corporation, you may want to review your corporate and personal tax situation annually to determine an appropriate level of compensation.
Under current law, corporate dividends meeting certain requirements are taxed to individual shareholders at a relatively low rate — no more than 15%. Qualified dividends that otherwise would be taxed in the lowest two individual tax brackets are tax free. Because this highly favorable tax treatment is set to expire after 2010, corporations should take this opportunity to evaluate the possibility of paying dividends.
A "small corporation" is not subject to the AMT. This exemption applies where average annual gross receipts for all three-year periods beginning after 1993 and ending before the current year don't exceed $7.5 million. For the first three-year period, a $5 million average gross receipts threshold applies.
Pass-through taxation.
Instead of paying tax at corporate rates, a corporation meeting certain requirements may elect to be taxed as an “S” corporation. An S corporation generally isn’t taxed on its income at the federal level. Instead, the company’s income, deductions, losses, and credits are divided up and taken into account by the shareholders on their own tax returns. The double taxation that can be a problem with a regular C corporation is avoided.
Example
After they incorporated their business, Jamie and Maria filed a timely S election with the IRS. The first year, the company had taxable income of $60,000. That income was not taxed to the corporation. As equal shareholders, Jamie and Maria each included $30,000 of the corporate income on their personal returns.
Partnerships, limited liability companies (LLCs) taxed as partnerships, and sole proprietorships are other entities that avoid two layers of income tax. If you have any specific questions about these business forms and how they can meet your needs, please let us know.
Spouses who own and operate an unincorporated business may elect to be taxed as a qualified joint venture instead of a partnership. Making the election avoids the need to file a separate partnership return for the business.
Net operating losses (NOLs).
If your business shows a loss for the year, the silver lining is that it may provide a tax benefit. A C corporation’s NOL is taken into account at the corporate level. S corporation shareholders and owners of unincorporated businesses account for NOLs on their personal returns.