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.

• 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.

A corporation is a separate legal entity that holds independent liabilities. 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 economy. 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 corporation" has to report corporate returns by filing Form 1120. However, if a company files its returns using Form 1120-S, it is an "S corporation." 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 Income (AGI) can be obtained by deducting the applicable adjustments from gross income. The Gross Income 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 deductions, but if the taxpayer does not claim that, the standard deduction will be applied.

Now, let us go through the basic steps involved in the calculation of the corporate tax:

1. First, find the adjusted gross income and the allowed deductions to compute the taxable income.
2. Evaluate the corporation's taxable income using this formula: Taxable income = Adjusted Gross Income - All Applicable Deductions.
3. 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.

Solution:

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.

Firms can legitimately reduce the taxable income by utilizing tax planning alternatives—not to be confused with unethical means—non-payment or tax evasion. 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 infrastructure, defense, and transportation.
• Tax Deductions: Companies can seek tax deductions on employee medical insurance, employee wages, and other employee expenses. Bad debts 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) refers to a particular region with specified boundaries providing competitive infrastructure and tailored laws to attract foreign direct investment into the nation.

According to the Internal Revenue Service (IRS), the following expenses can be deducted from taxable income:

• Business losses;
• All ordinary and necessary corporate expenditures;
• Business expenses for bookkeeping, 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 tax, and fuel tax.

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 -

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