Tax Formula
Taxing a corporation is different from taxing an individual for a few reasons:
- Corporations do not calculate adjusted gross income
- Businesses do not take a standard deduction
- All expendituates are assumed to be business related
- There is a flat rate of 21%.
So, the basic business tax formula is: Gross income – Deductions = Taxible Income. Taxible Income x Tax Rate = Gross Tax Liability. Gross Tax Liability – Credits and Prepayments = Net Tax Liablity.
Accounting Periods and Methods
While an individual is required to use the fiscal year for their accounting period, corporations can choose their accounting period. Most corporations use the fiscal year anyways. The one caveat is that the bookkeeping period must be the same as the tax period.
As for an accounting method, corporations are required to use the accrual method. S Corporations and a corporation engaged in farming (if gross receipts is less than $30 million) can use the cash method.
Capital Gains and Losses
Corporations capital gains are taxed as ordinary income (there is no rate preference like there is for individuals). Capital losses are only deductible (can offset) against capital gains. Any unused capital losses can go back three years or forward five years (there is no time limit for individuals).
Corporate Deductions
Corporations can take deducations for
- operating expenses
- charitable contributions
- dividends received deduction
- net operating losses
- organizational and start up costs
Operating expenses must be ordinary, with respect to the business, necessary to further the business, and reasonable in the amount (not excessive). If the expenditures go beyond a year, then the corporation will capitalize (meaning there is no immediate deduction) and will depreciate throughout the life of the asset.
Corporations are allowed to make cash or property (not services) donations to qualified charities and can deduct those amounts in the year paid. However, this is deduction is limited to only 10% of the initial taxable income (not gross income). Any excess can be carried forward only five years into the future.
Corporations can deduct interest expenses. However, this is limited to: Interest Income + 30% of Adjusted Taxable Income (Business Income + Net Operating Loss Deductions). Any excess can be carried forward indefinitely.
Corporations can deduct dividends received deductions. Essentially, every time a dividend is paid to a corporate shareholder, they are taxed at 21%. To mitigate this, they are allowed to take a portion of the dividend received to deduct from taxible income. The amount to be deducted is based on what percentage the stock is owned. Most corporations can deduct 50% because most corporations own less than 20% of the corporation paying the dividend.
Corporations can deduct the net operating loss in future years when they have an income. The current limitation though is that you can carry forward any total forward indefinitely, but can only take 80% of income before the net operating loss.
Corporations can deduct expenses from compensating executives. However, this is limited to publicly traded firms and can only deduct to 1 million dollars for each of the top five executive officers. Compensation can include: salaries, bonuses, incentive compensation, taxable benefits.
A corporation can deduct the expenses required to organize the corporation. These include legal fees, accounting services, incorporation costs. A corporation can deduct the first $5,000 immediately (up to 50,000). The rest is ammoratized over the next 180 months (15 years).
Start up expenditures are treated the same way as organizational costs. The difference is that the costs are incurred after the organization exists.
Tax Formula Revisited
Gross Income – Operating Expenses – Charitable Contributions – Dividends received deduction – Capital Loss Carryback = Taxable Income
Related Corporations
If two subsidiaries, their income combines and there is a higher limit to the deductions.
If so desired, parent-subsidiary affiliated group may choose to file a consolidated return. To do so, there is a requirement of 80% ownership in all subsidiaries, a single return is filed, losses offsets income, and inter-company transactions are limited.
Filing requirements
File form 1120 due April 15th (same as individuals). If corporations don’t pay dividends, they are required to pay an accumulated earnings tax.
Differences between Tax Returns and Book Income
There is a distinction between net income and taxable income because net income removes taxes to get to the number.
Additionally, there are temporary and permanent differences. Temporary differences means that there are some items that would appear on each document, but not at the same time (e.g., depreciation). Permanent differences are items that never appear on both documents (e.g., fines and dividends received deduction).
Deferred taxes refer to the taxes owed during different years. That is, the tax expense may be different from teh taxes paid. Any differences between tax income and book income need to be listed on the Schedule M1 or M3 on the corporate tax returns.
