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Corporate Tax Rates 2010

Corporate taxation is unique in that the business itself is subject to an income tax. Note how this is different from a sole proprietorship or a partnership in which the business itself is not taxed, but the owners are taxed based upon their allocated share of the income.

A C-corporation’s income tax is unaffected by how many owners (shareholders) the corporation has or by how much of the profit is distributed to the owners. C-Corporation income is taxed according to the following table:

Tax Rates for Corporations (2010)

$0-$50,000 15%
$50,001-$75,000 25%
$75,001-$100,000 34%
$100,001-$335,000 39%
$335,001-$10,000,000 34%
$10,000,001-$15,000,000 35%
$15,000,001-$18,333,333 38%
Over $18,333,333 35%

Double Taxation of Dividends

When a corporation makes a distribution of earnings to its owners, the payment is known as a dividend. Dividend income is taxable to the recipient (though at a maximum rate of 15% as compared to ordinary income rates).
As such, corporate profits, if they are paid out to shareholders, will be taxed twice: Once at the corporate level and once at the shareholder level.

Paying Yourself a Salary

One way to avoid the double taxation of the corporate structure is to pay the owners a salary—or year-end bonus—that will leave the corporation with exactly zero income. (Salaries paid to employees count as deductions for a corporation, thus reducing the corp’s taxable income.)

Of course, the amount received as salary will still be taxable income to the owners. In fact, when a corporation pays its owners a total amount of salary equal to what profits would have been without the salary, the net result is actually exactly the same as if the business was simply being taxed as a sole proprietorship or partnership. How about an example
to clarify?

EXAMPLE: Debbie is the only owner of her business (a dietetics-consulting practice). Her business is currently a sole proprietorship, but she’s attempting to determine if forming a C-corp would be beneficial. Her revenues for the year are projected to be $90,000, and her expenses (not counting any salary she pays herself if she incorporates) are projected to be $20,000.

If Debbie continues to run her business as a sole proprietorship, she’ll have $70,000 of earnings from self-employment. (And regular income tax and Self-Employment Tax will be computed as normal.)

If Debbie decides to incorporate and pay herself a $70,000 salary, the corporation will have a taxable income of $0. She’ll have $70,000 of salary, upon which she’ll pay regular income taxes. She won’t have to pay Self-Employment Tax. But she and the corporation will each be responsible for 7.65% of social security and Medicare taxes, totaling 15.3% anyway.

End result: Debbie pays the same total amount of tax in each scenario.

Potential for Savings: Income Splitting

But what if a business owner doesn’t need every last dollar of her business’s profits in order to pay her personal bills? Such situations are the reason why people sometimes discuss incorporation as a method to save on taxes.

Often, business owners can pay less total tax if they’re comfortable leaving some money in the business’s bank account. They can pay themselves a salary, but not a salary so large that it wipes out the corporation’s profits entirely. The end result is that the corporation has some taxable income, and the owner has some taxable income. The tax savings are achieved because the income is split between the owner and the corporation (thus keeping them each in a lower tax bracket).

EXAMPLE: Let’s use the same information from the example above, and assume that Debbie has decided to incorporate. But we now have one more piece of information: Debbie lives a very simple lifestyle, and knows that she won’t need all of the profits from the business in order to pay her personal bills. In fact, she only expects to need $30,000 of income in order to maintain her standard of living.

Debbie realizes that she can save money by splitting her taxable income. She decides to pay herself a salary of $30,000, and let the rest of the profits ($40,000) remain in the corporation’s checking account. This way, the corporation has a taxable income of $40,000, and she has a taxable income of $30,000, and she ends up paying less total tax than she would if all $70,000 of income were taxable either to herself or to the corporation.

Qualified Personal Service Corporations

As mentioned in the previous chapter, many types of professionals (doctors, lawyers, etc.) are barred from forming corporations in certain states. However, some states do allow them to incorporate.

The IRS is likely to treat such corporations as “Qualified Personal Service Corporations.” This designation isn’t a positive one. What it means is that the corporation’s income will be taxed at a flat rate of 35%, rather than the rates shown above, which begin as low as 15%.

Two requirements must be met for the IRS to assign the designation of Qualified Personal Service Corporation:

  1. Substantially all of the corporation’s activities are services performed in the fields of law, medicine, engineering, accounting, architecture, performing arts, actuarial science, or consulting.
  2. 95% or more of the corporation’s stock is owned by employees performing the above-mentioned services, or by retired employees, the estates of employees, or other people who acquired the stock as a result of an employee’s death.

Simple Summary

  • Unlike sole proprietorships or partnerships, C-corporations are taxable entities. That is, they have to pay tax on the income they earn.
  • After a corporation is taxed on its income, it can distribute it to the owners (in a payment known as a dividend). The owners are then taxed on the dividend income, thus resulting in two levels of taxation.
  • It’s possible to achieve some tax savings by utilizing income splitting if you think your business is likely to generate more income than you need for personal use.
  • If a corporation is ruled to be a Qualified Personal Service Corporation, its income will be taxed at a flat rate of 35%.

For More Information, See My Related Book:

Book6FrontCoverTiltedBlue

LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less

Topics Covered in the Book:
  • The basics of sole proprietorship, partnership, LLC, S-Corp, and C-Corp taxation,
  • How to protect your personal assets from lawsuits against your business,
  • Which business structures could reduce your Federal income tax or Self-Employment tax,
  • Click here to see the full list.
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