How much a corporation pays in taxes depends on how it is structured. C-corporations are taxed twice. The company is taxed at the corporate tax rate, and owners or shareholders are taxed on the income they receive from the corporation. S-corporations are only taxed once as all profits flow directly to the owners or shareholders. Corporations may also be taxed at the state or local level.
Before 2017, the federal corporate tax rate was 35%. Today, it is 21%. States and local municipalities set their own tax rates. For example, New Jersey has the highest corporate income tax rate at 11.5% as of 2022. South Dakota and Wyoming do not impose an income tax or a gross receipts tax on corporations.
What is the Corporate Tax Rate?
At the federal level, corporations are taxed on their income after deductions. Despite the official federal tax rate of 21%, corporations pay an average effective tax rate of 11%. In some states, such as Ohio, Texas, and Washington, corporations are taxed on their gross receipts rather than their income.
How Are Corporate Taxes Different?
Corporate taxes use different deductions and credits when calculating taxable income. For example, businesses may deduct expenses related to research and development, oil and gas exploration, and multiple industry-specific credits. Corporations are only taxed on income earned in the United States. For companies doing business in other countries, the income is taxed when it is repatriated or brought into the United States. As long as the funds remain outside the US, they are not taxable.
How to Reduce Corporate Taxes
Tax planning can help reduce corporate taxes through accelerated depreciation, tax credits, stock options, and income deferral. It can help corporations take advantage of all available deductions. Let’s look at a few tax-reduction strategies.
Accelerated or bonus depreciation means companies can deduct an asset’s cost over several years, even at a rate that exceeds the asset’s actual depreciation. For example, a corporation purchases a new facility. Companies can deduct the cost of the facility over years, making it possible to reduce corporate tax in each year a deduction is taken.
The Tax Cut and Jobs Act (TCJA) passed in 2017 and changed the accelerated depreciation to allow full expensing of an asset. Now, a company buying a new facility can deduct the entire cost in the same year as the facility was purchased.
Large corporations often keep income earned outside the US in foreign countries where they have subsidiaries. Income earned outside the US is not taxed until it is repatriated or brought into the country. By establishing a presence in countries with minimal taxes, these companies can reduce their US tax liability.
Under the 2017 TCJA, offshore funds can be used to borrow against or invest in US assets. Because the funds are not brought into the US as income, the money is not taxable. Technology companies such as Apple and Microsoft have billions held offshore from non-US sales.
Companies often use stock options as a way to compensate company executives. Executives are given the option to purchase shares at a set value in the future. For example, an executive has the option to purchase 100 shares at $25.00 per share. After five years, the company’s stock has doubled. The executive purchases the shares at $25 and sells them for $50, making $25 per share.
When the options are offered, accounting practices require that the company estimate the possible value when the option is exercised. The value is then recorded as a compensation expense. When the shares are sold, the company claims a tax deduction for the difference between the option price and the sell value.
C-corporations can deduct charitable donations up to 10% of their taxable income. If they do donate more than the eligible amount, they can carry over the deductions for the next five years. Not only do organizations receive a tax deduction, but they can also receive social good will.
As the world becomes more focused on environmental, social, and governance issues (ESG), charitable donations improve a company’s reputation as a positive contributor to ESG concerns.
Corporate Tax Credits
The government uses tax credits to encourage businesses to invest in areas that serve the national interest such as using alternative energies to reduce dependence on fossil fuels.Corporations need to take advantage of these credits. Some credits are permanent while others temporary.
A general business credit refers to a group of credits available to all businesses. These include such things as social security and employer-provided childcare credits. Three credits that apply to specific industries or employers are research, orphan drug, and employment credits.
The Credit for Increasing Research Activities became a permanent credit in 2016. The credit applies to any qualified research expenses incurred while developing new or improved products, software, or manufacturing processes. The credit’s value depends on how the research expenses are calculated. For corporations that invest significantly in R&D, the tax credit can reduce corporate taxes.
Orphan Drug Credits
The Orphan Drug Credit was created to encourage the development of drugs to treat or cure rare medical conditions or diseases. The tax credit for these so-called orphan drugs can be up to 25% of the cost of clinical trials. The credit is based on expenses such as administrative staff, contractors, and clinicians.
A Work Opportunity Tax Credit (WOTC) is a temporary tax credit. The credit is available through 2025 for companies that hire qualified workers such as veterans, ex-felons, and SNAP recipients. The credit is based on the first $6,000 paid to a qualified employee in a year. For employees working 120 to 400 hours the credit is 25% of the wages. Employees working more than 400 hours the credit is based on 40% of the wages. The credit cannot exceed $2,400 per employee.
DHJJ Can Help
Tax planning can help corporations decide the best tax-reduction strategies. Successful implementation of the strategies requires a thorough understanding of the US tax code. It also needs financial professionals who understand a company’s vision. At DHJJ, our team works with clients to develop a sound strategy to reduce corporate taxes. Contact us at 630.420.1360 or complete our online contact form if you’re looking to reduce your corporate taxes.