Income taxes for corporations and corporate owners (shareholders) have changed in the past few years, in part due to the Tax Cuts and Jobs Act (TCJA) of 2017, and also from changes in state tax laws.
Proposals made by the Biden Administration in April 2021 could roll back TCJA reductions and lead to even greater increases, but the proposal faces a fight to get through Congress.
Federal and State Business Income Tax Rates
The federal corporate tax rate was reduced from a stepped rate up to 35% to one flat rate of 21% effective with the 2018 tax year and beyond. This rate applies to corporations whose tax year began after Jan. 1, 2018.
State corporate tax rates have also changed. Fifteen states and the District of Columbia have cut corporate taxes since 2012, and several more made tax rate cuts in 2020.
An overhaul to the New York State tax code in the wake of the pandemic increased corporate taxes as well as those paid by S corporations and LLCs.
Capital Gains Taxes for Corporate Shareholders
Corporate shareholders don't pay taxes on corporate income. They receive dividends, which are taxed as capital gains. The capital gains tax rate depends on whether the gain is short-term (on assets owned for one year or less) or long-term (owned for more than a year).
The capital gains tax rate is no more than 15% for most individuals, and some or all of net capital gain may be taxed at 0% if taxable income is less than $83,350 as of 2022. Higher-income individuals may pay capital gains tax at 20% if their taxable income exceeds a threshold, depending on their filing status.
A proposal from the Biden Administration made in late April 2021 would increase capital gains taxes to 39.6% on individuals with incomes over $1 million. It would also raise the corporate tax rate to 28% and eliminate many deductions that allow large companies to pay nothing.
Taxes for S Corporations
The tax rate for S corporations is the tax rate for the owners. An S corporation doesn't pay tax as a corporation. The tax is passed through to the shareholders (owners) instead, who report the income and pay the tax on their personal tax returns.
Each shareholder receives a Schedule K-1 showing the owner's share of distribution (not including dividends).
The taxable amount of the shareholder's distributions is set based on the shareholder's stock basis (what the person paid for the stock originally).
S corporation shareholder distributions (not including dividends) are taxed as capital gains on the owner's personal tax return. The gain is a long-term capital gain if the stock has been held longer than a year.
Shareholders of corporations and S corporations receive a 1099-DIV form each year showing the dividend income for a tax year. This income is taxed as a capital gain. Report capital gains or losses from corporation dividends or S corporation distributions and dividends on Schedule D Capital Gains and Losses.
Blended Tax Calculation for 2018 Filing
If your corporation's tax year began before Jan. 1, 2018, and it ended after Dec. 31, 2017, you would need to figure and apportion your tax amount by blending the rates in effect before Jan. 1, 2018, with the rate in effect after Dec. 31, 2017. The IRS has a worksheet (on page 18) to help you with this calculation.
State Taxes for Corporations
Most corporations must pay state income tax. State tax rates for corporations range from 2.5% in North Carolina to 11.5% in New Jersey. Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming, have no corporate income tax.
Accumulated Earnings Tax
Corporations must pay an additional accumulated earnings tax of 20%, in addition to the regular corporate taxes, if the corporation doesn't distribute or pay dividends. This tax is imposed by the IRS to prevent corporations from piling up earnings and not distributing them to shareholders in the form of dividends, thus avoiding the tax on the dividends.
The IRS looks at an accumulation of $250,000 or less as reasonable, ($150,000 for a business that performs professional services). The corporation needs a bona fide business reason for accumulating earnings, such as actual moves to expand the business. The burden is on the corporation to justify the need to accumulate earnings.
Corporations and the Double Tax Dilemma
The profit of a corporation is taxed to the corporation when it is earned, then it's again taxed to the shareholders when it's distributed as dividends. This creates a double tax. The individual shareholders must report this income on their individual tax returns if the corporation distributes all or part of its income to shareholders as dividends.
The stock basis discussed above is considered a return of capital investment if the corporation pays a shareholder back for investment in the company. Only amounts over the stock basis are taxable to the shareholders.
Some corporations attempt to avoid the shareholder dividend tax by not distributing dividends. But the IRS can impose the accumulated earnings tax discussed above if the corporation attempts to avoid dividend taxes for shareholders.