How are C corporations taxed? Tips on how to avoid double taxation and reduce taxes

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How are C corporations taxed?

When are C corp taxes due?

How do C corps file taxes?

How can C corporations reduce their taxes?

Setting up your business as a C corporation (C corp) has many benefits, including greater ownership flexibility and more growth potential than an S corporation (S corp) or a Limited Liability Company (LLC). But what does that mean for your taxes? And what tax benefits and strategies are available to a C corp that aren’t available to an S corp or LLC?

The following is a guide to the most common questions current and prospective business owners have about C corp taxation and strategies for lowering a C corp’s tax burden.

How are C corporations taxed?

The IRS taxes C corps as “separate taxpaying entities” that engage in business, earn revenues, realize profits and losses, and distribute profits or dividends to corporate shareholders. In other words, C corps are not taxed as individuals, they are taxed as a business structure that is legally separate from the people who own and operate the business.

In addition to various rules for income tax deductions and depreciation, C corps also pay several other types of taxes, such as property taxes, payroll and unemployment taxes, sales and use taxes, and excise taxes—though some of these costs are passed on to consumers.

One unique aspect of C corporations is that they are subject to “double taxation.” This means that a C corp’s profits are effectively taxed twice.

What is “double taxation”?

For C corps, double taxation refers to the taxation of corporate profit at two different times: First, the corporation itself is taxed on their corporate income at the federal corporate tax rate of 21%. Second, when corporate earnings and any dividends or profits are passed on to shareholders, that same profit is taxed as capital gains on the shareholders’ personal tax returns at an individual tax rate of 10-37% —hence the term, double taxation.

C corps cannot deduct earnings distributed to shareholders, either, though there is no shortage of proposals to change this unfortunate fact.

Taxes to pay on C corp dividend distributions

C corp shareholders must pay individual taxes on any distributions of dividends, or net profits, and the tax rates they pay are calculated based on the individual’s income-tax bracket. To avoid double taxation, then, the owner of a C corp—particularly a small one—may not want to receive dividends, because they are a form of taxable compensation. In any case, dividends from a C corp are reported on Form 1099-DIV, and these forms are due each year on Mar. 31.

Taxes to pay on C corp capital gains

While capital gains for individuals are taxed at a lower rate, net profits and capital gains at the corporate level are taxed at the same corporate rate: 21%. Nevertheless, companies must record any capital gains as either short-term or long-term gains on their Schedule D, Form 1040, even though they are taxed at the same rate. Companies can offset capital gains with capital losses, but these offsets should not be confused with expense deductions from income, which are recorded separately.

When are C corp taxes due?

The tax deadlines for C corporations depends on if they follow a calendar or fiscal year:

• If a business follows a calendar year, C corp taxes are due the same time as other calendar-year taxes are due, which is the 15^th day of the 4^th month after the close of the tax year, unless that day falls on a weekend or a holiday, in which case they are due on the nearest business day afterward.
• If a C corp business uses a fiscal year, its taxes are due on the 15th of the fourth month after the end of its fiscal year. For example, if a C corp’s fiscal year ends Mar. 1, its taxes are due July 15, unless that day falls on a weekend or a holiday.

If a C corp cannot meet its initial tax deadline, it can file for a six-month extension using
IRS Form 7004. In 2024, the extension deadline for calendar-year businesses is Oct. 15. For fiscal year businesses, the deadline is the 15th of the month six months after the initial fiscal deadline.

How do C corps file taxes?

C corps file federal income taxes using IRS Form 1120, the U.S. Corporation Income Tax Return. These taxes are based on net earnings, which are calculated after allowable deductions are taken. Deductions may include the cost of sales, wages, travel, other types of employee compensation, advertising costs, some types of interest costs, other taxes, and depreciation costs.

How can C corporations reduce their taxes?

C corporations can lower their taxes and avoid double-taxation in a number of ways. Following are some of the most common strategies to save on taxes:

• Withhold dividends: Withhold dividend distributions, so that the company’s income only gets taxed once at the federal level of 21%. However, some shareholders may not approve of this tactic if it means giving up passive income, and suspicions can arise at the IRS if a C corp never pays dividends.
• Pay salaries, not dividends: Pay shareholders who work for the corporation salaries instead of dividends. This option works because salaries are taxed at individual tax rates, but are deductible for the C corp, whereas dividends are not deductible.
• Reimburse shareholder expenses: If a C corp directly reimburses business expenses incurred by shareholders, it can deduct these reimbursements and reduce its total earnings, thereby avoiding double taxation. However, the shareholder cannot then turn around and deduct those same expenses on their individual return.
• Maximize deductions: A C corp can further reduce its earnings (the amount taxed at the federal level) by taking all possible deductions available to it, including (but not limited to) travel expenses, equipment rental, utilities, health plan costs, entertainment, consulting services, legal expenses, depreciation, advertising costs, charitable contributions, etc.
• Record a net operating loss: C corps are taxed on their income, but if a business’s losses after deductions exceed its income, it is not liable for taxes that year.
• Carry over net operating losses: If a C corp records net operating losses in one year, it can carry over up to 80% of those losses to the following year, further reducing its taxable income.
• Accelerate depreciation: When a C corp purchases equipment such as computers, printers, or machines for manufacturing, it has the option of depreciating the cost evenly over several years, deducting more depreciation in the earlier years of the equipment’s lifespan, or deducting it all at once in the first year.
• Claim tax credits: Many businesses are eligible for a wide range of credits, which differ from deductions in that they are subtracted directly from earnings. The IRS lists dozens of possible credits, but the most common ones are:
  • Energy credits (for various sustainable energy practices)
  • Research and development credit
  • Investments credits (to encourage investment in manufacturing and sustainability)
  • Work opportunity tax credit
  • Pension-plan start-up credit
  • Disabled access credit
  • Employee-provided childcare credit
• Claim a General Business Credit: Non-publicly traded companies that make less than $50 million per year can also claim what’s known as a General Business Credit (IRS Form 3800), which combines the total value of all the credits a business has taken into a single credit for a specific year.

Conclusion

Though C corps are subject to double taxation, the C corp business structure offers numerous benefits, especially for companies on an aggressive growth path. From a tax standpoint, C corps also provide advantages for smaller business owners, such a mechanism for avoiding the self-employment tax and greater flexibility when it some to deductions, salaries, and dividend distributions.

That said, C corp taxes can be extremely complex, and only an experienced tax professional can explain how all the rules might apply to any given organization. Many C corporations hire accountants and lawyers to hone their tax strategy, of course, but there are other options for business owners that want to manage their own affairs. For example, there are many corporate income-tax software solutions capable of managing a C corp’s taxes, and a sophisticated corporate tax software platform such as Thomson Reuters ONESOURCE has a wide variety of tools for almost any tax situation.