Here's a bit of trivia: What type of tax is so often misunderstood that economists label it indefensible and inefficient? The same tax results in notable contortions in economic activity. Although it's supported by the average layperson on the street, very few people even know who bears the burden of such a tax, and many mistakenly attribute the payer as someone it isn't. Unsure? The answer is the corporate income tax.
Just as many consumers (incorrectly) believe corporations pay the corporate income tax, many business owners and managers (incorrectly) assume that the burden is passed along to consumers. Meanwhile, this example of the corporate cat chasing its tail explains why the tax remains popular among politicians.
There are two significant ways that corporate taxes differ from individual taxes, and recognizing them may save you a lot of time and money. First, the corporate tax is only applicable to organizations identified as corporation's not to partnerships or sole proprietorships. Secondly, the money collected is only assessed on profits, or net income not a corporation's gross income.
Federal tax rates vary according to different brackets of income, with graduated levels of payment between 15 and 39 percent. Corporations with less than $50,000 of taxable income pay 15 percent, businesses with income between $50,000 and $75,000 pay 25 percent, and rates range from 34 to 39 percent for income above that level. Most corporations face the maximum rate possible.
Tax rates for individuals follows much the same pattern. As of 2016, the top personal rate for a couple filing jointly and single filers is 39.6 percent, identical to that of corporations. Individuals earning less than $37,650 must pay 10 to 15 percent, whereas individuals earning between $37,650 and $91,150 are taxed at 25 percent. Rates vary between 28 and 39.6 percent beyond those figures.
In other words, there is no appreciable difference paid on the lower end of the financial spectrum for corporations versus individuals. As income increases, however, the tax burden becomes increasingly heavy for corporations. If your business is going to pull in substantial profits, consider using the S corporation filing status or having your LLC taxed as a partnership.
States levy additional taxes on corporations, with rates typically ranging from 3 to 12 percent. Most states allow business owners to deduct federal tax expenses, so net rates vary between 1.9 to 4.9 percent. Some local areas impose another tax on corporations. Businesses avoid these costs by relocating out of areas or states with particularly high income tax rates.
Following individual income tax rates and payroll taxes, corporate income taxes garner the largest source of revenue for the federal government. In fiscal year 2015, the total revenues were expected to reach $3.8 trillion. Of this, $1.48 trillion, or 47 percent of all tax revenues, stemmed from individual tax payers. By comparison, $1.07 trillion, or 34 percent of all tax revenues, came from payroll taxes garnered from employers and employees. Corporate income taxes paid by businesses accounted for $341.7 billion, or 11 percent of all tax revenue. Smaller amounts of federal revenue resulted from other taxes, such as excise taxes and customs duties.
Few people would argue that the corporate income tax serves a purpose. Other than filling the government's pockets, it helps restrict individuals from accumulating tax-free income within corporations. It also encourages debt finance comparative to equity finance, since the interest payments of corporations are deductible, whereas dividends are not. Furthermore, the corporate income tax persuades corporations to keep earnings instead of paying dividends.
On the other hand, the imposition of taxes on corporations twice, once when earned by the corporation and again when paid out to shareholders, dissuades business owners from utilizing the corporate form of enterprise relative to non-corporate forms. This dual tax process developed years ago when corporations received state-granted benefits, such as exemption from specific laws, thereby acting as an incentive for owners to pay for such services. Now that states merely serve as registrars and tax collectors, this tax is less justified.
Since it does exist, however, it is up to business leaders and individuals to understand the notable differences between the types of taxes and what it means to file as a corporation versus as an individual. Deciphering which tax is appropriate to your situation can be complicated. Most small business owners and high-wage individuals benefit from hiring a CPA to understand the nuances between corporate income taxes and individual income taxes.
As tax laws continue to evolve, CPAs must stay abreast of the changes to keep licensing up to date. This can be invaluable to you, as a business leader or individual, so that you can avoid mistakes apt to lead to auditing errors. Make sure that you can have representation, in case an audit does take place. CPAs provide an in-depth and thorough analysis of, and advise about, tax and financial matters.
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