The final stretch of the fiscal year is coming to an end. As you put the finishing touches on your company’s books, you can’t help but wonder whether there’s something more that could be done to optimize your tax strategy moving forward. Tax season is a time for accounting pros to put their skills to test and ensure that their company is paying only what it needs to pay. However, the world of corporate taxation is always evolving. New laws are introduced almost every year, so from the general principles of corporate tax to specific implications of the new Tax Cuts and Jobs Act , here are some things you need to know about corporate taxation in order to keep your firm compliant this tax season.
Tax Basics for Corporations
For starters, we need to understand what constitutes a corporation for tax purposes. A corporation is a business entity that has been legally recognized as having the capacity to act as a person. This means it can own assets, make contracts, and be sued for its actions just like a person would. Because corporations are recognized as separate from their owners for tax purposes, a corporation can be taxed at either a corporate level or its shareholders can be taxed on their dividends.
The Basics of Taxable Income
Taxable income, or taxable profit, is the amount a corporation has left after deducting all allowable business expenses. The thing is, taxable income can be different from what a company reports as profit. When calculating taxable income, corporations are allowed to deduct various elements from their gross revenues. These deductions are based on relevant tax laws. And since one of the main purposes of corporate taxation is to distribute the tax burden among different sectors of the economy, the amount of taxes a corporation pays depends on two things: the type of business it’s engaged in and its taxable income. For example, corporations that generate a lot of taxable income are taxed at higher rates than those that have lower taxable income. For this reason, corporations try to reduce their taxable income by taking advantage of deductions and credits that are offered by the government.
Deductions and Losses in Taxable Income
A significant portion of a corporation’s gross revenue is usually spent on business expenses. In fact, the gross revenue you report to shareholders is often different from the taxable income you report to the government. That’s because you can deduct certain expenses from your gross revenues to arrive at your taxable income. There are different types of deductions corporations can take advantage of, but two of the most common are deductions for business expenses and deductions for inventory write-offs. For business expenses, corporations can deduct any amount spent on activities essential to their daily operations, e.g., salaries, rent, utilities, and repairs. Inventory write-offs pertain to unsold goods, i.e., goods that are expected to remain unsold for longer than one year.
Corporate Tax Rates
For any business, taxes are often calculated as a percentage of taxable income. This means that a company’s tax rate is the percentage of its taxable income that it needs to pay the government in taxes. For corporations, the tax rate depends on the type of business they’re engaged in, the amount of taxable income they have, and other relevant factors. Since the Tax Cuts and Jobs Act (more on this below) was signed into law in December 2017, there have been several changes to corporate tax rates, including a reduction in the corporate tax rate from 35% to 21%. Additionally, corporations that generate a small amount of taxable income are exempted from paying any taxes.
When Do Companies Pay Taxes?
Many people don’t realize that corporations, not their shareholders, are responsible for paying taxes. This means that a company’s annual tax liability depends on its taxable income, not its profit. However, what shareholders actually pay in taxes depends on the type of corporate tax structure a company uses. Corporations can be taxed as S corporations, C corporations, or a combination of the two. S corporations are usually owned individually by shareholders who report their shares of the company’s profits and losses on their personal income tax returns. In contrast, C corporations are taxed at the business level and then again at the shareholder level.
A Quick Note on Equity Compensation
As you know, the TCJA made significant changes to the taxation of corporations and individuals. One of the major changes that may have a significant impact on the structure of your company is a reduction of the corporate tax rate. This means that corporate tax obligations will be lower, which means that in turn, companies will be able to use their profits to provide better benefits to their employees. For example, they can offer higher salaries or sign more lucrative stock options and shares. Having said that, you should note that the TCJA also introduced what is called a “cash-out” rule . This rule says that if a company issues equity compensation, it must cash out the value of that compensation at the time the compensation is granted.
Lessons from the New Tax Cuts and Jobs Act
The TCJA is a significant piece of legislation that aims to simplify the federal tax code and allow corporations to operate more efficiently. For example, it increases the standard deduction, which means that fewer people will use an itemized deduction. And since corporations can use itemized deductions less often, the new law reduces corporate tax rates. The TCJA also includes a repatriation provision, which allows companies to bring back money that is stashed away abroad and pay a one-time tax rate on it. This could mean more cash in a company’s coffers, which, in turn, could be used to invest in new projects, hire more employees, or increase salaries.
So, to recap, the world of corporate taxation is always evolving. New laws are introduced almost every year, so from the general principles of corporate tax to specific implications of the new Tax Cuts and Jobs Act, here are some things you need to know about corporate taxation in order to keep yo