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Tuesday, March 22, 2011

How a C corporation is taxed

C corporations are the largest of U.S. corporations and also subject to the most extensive tax reporting requirements and documentation. C corporations may include a private company with 200 shareholders or a large publicly traded company with market capitalization in the billions of dollars. C corporations are subject to reporting a lot of financial activities and thus require strong bookkeeping and documentation throughout the tax year.

Tax forms required


There is a considerable amount of required documentation for filing as a C corporations. The primary IRS form is the 1120 which is different from the 1120S, a tax form required for S-Corporations which are small businesses with 100 or less shareholders. The form 1120 also includes several schedules that are used for calculating cost of goods sold, tax credit, total officer compensation, balance sheet items and dividends. The necessary documents to fill out and their complete instructions are freely available through the Internal Revenue Service.

How tax is calculated for C corporations


A primary factor in the calculation of how much a corporation will be taxed is retained income. The higher the retained income, the higher the tax imposed on the corporation will be. Since retained income is the bottom line after expenses and costs have been deducted this number can end up being quite a bit lower than revenue from sales and sometimes even negative in which case no tax is applied.

The idea that a C corporation is subject to double taxation is theoretically true but in cases where the shareholders do not sell their shares of the company they are not taxed capital gains tax. In other words, capital gains taxes are only charged following sales of shares and dividends are both deductible from taxation before earnings and taxed a lower rate than capital gains to shareholders.

C corporation tax lowering strategies


There are several ways to lower the tax of a C corporation. Specifically, since state taxation is also a factor, choosing to headquarter and/or operate a C corporation out of state with favorable business laws can be advantageous. For example, operating out of Nevada can be beneficial for a C Corporation because there are no state taxes or franchise fees imposed on the businesses. For C corporations that don't mind operating out of the U.S. mainland, the territory of Puerto Rico also offers significant tax advantages.

Additional strategies include the paying out of dividends or redirecting profits into a dividend reinvestment program (DRIP), profit sharing plans and./or pensions, both of which are tax deferred to participants and tax deductible to the corporation. Other options can include forming a different corporation altogether, for example a non-profit corporation or a MREIT in the case of real estate investment companies. The latter of these pays no taxes because the profits are either reinvested into the company or distributed among shareholders in the form of deductible dividends.

Another interest tax fact about C corporations is that in tax years where the company experiences a net loss, not only does the company not pay taxes, but the loss can be carried over to the following year and deducted from the total earnings of that year or any other year up to 5 years after the year of the loss. This is an incentive to assist struggling C corporations or C corporations in financial readjustment regain profitability without tax burden.

C corporations are one of several types of businesses identified within the United States tax code. C corporations are the largest type of corporation and subject to the highest amount of tax reporting requirements. However, C corporations are also able to deduct significantly more from revenue numbers than smaller corporations and the double taxation often associated with C corporations can be avoided with drips, long term holding of shares, and various other tax strategies including but not limited to net loss carry over from previous years, state or territory of operation and profit sharing plans.

Sources:

1. http://www.irs.gov
2. http://www.expertlaw.com/library/business/c_corporation.html