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Corporate tax – definition and meaning

Corporate tax or corporate income tax is a levy that governments collect on the profits of companies. In the United Kingdom, people call it corporation tax. In Ireland and Australia, they say company tax. Corporate tax is a major source of government revenue. In fact, typically the third largest in the advanced economies. The largest source of government revenue is individual income tax, while the second largest is payroll taxes.

In the United States in fiscal 2015, the federal government raised $343.79 billion in corporate tax. As in the other advanced economies, it is the US government’s third largest source of income. However, over the past half century, it has been declining as a proportion of total government income.

Companies calculate their operating earnings by deducting expenses including COGS and depreciation from revenues. COGS stands for ‘cost of goods sold.’

Businesses pay corporate according to how much profit they make. In some countries, there is a flat rate, while in others it is a sliding scale. In other words, the corporate tax rate rises as profits grow.

Corporate tax rates in the USA
These are the corporate tax rates that the Federal Government levies on companies’ profits. On top of this, we must add the taxes that individual States charge.

US corporate tax rate

Rules governing corporate taxation vary considerably from country to country. Among the advanced economies, the United States – at 40% – has the highest rate of corporate tax. The US corporate tax rate consists of a 35% federal rate plus a state rate. The amount that states charge varies.

In the UK and Ireland, for example, corporate tax rates are 20% and 15% respectively.

In the United States, corporate tax returns are due in by March 5th each year. Businesses may request a 6-month extension to have tax returns due in September.

Companies whose assets exceed $10 million, must file their Form 1120 (tax return form) online.

According to the United States’ Internal Revenue Service (IRS), all businesses must file an annual income tax return. Partnerships, however, file an information return. Which form you use depends on how you have organized your business. The IRS’ Business Structures section explains the details.

In most countries, companies based abroad must pay tax on the profits they make in the host company. For example, Toyota, a Japanese company, makes profits in the United States. Toyota must pay corporate tax to the US government on its US profits.

Domestic companies that are liable for foreign corporate taxes usually receive a foreign tax credit for such taxes.

Corporate tax history in the US

The US Government enacted its first federal income tax in 1861. Amid constitutional challenges, it expired in 1872. In 1894, it enacted a corporate income tax. However, it was not long before lawmakers deemed it unconstitutional.

Congress exacted an excise tax on businesses based on income in 1909. Following the ratification of the Sixteenth Amendment of the US Constitution, it became the corporate provisions of government revenue.

Since then, there have been many amendments to US corporate taxation codes within the IRS. The 1986 Tax Reform Act introduced the current rate of tax.

By 2010, nine percent of all federal revenues came from corporate tax, compared to 32% in 1952. This represented 1.3% of GDP. GDP stands for gross domestic product.

Today, federal corporate tax rates in the US range from 15% to 35%. A company with a taxable income greater than $18,333,333 pays 35%. However, businesses with a taxable income of up to $50,000 pay 15%.

Corporate Tax versus Income Tax USA
Corporate tax rates have increased in the USA but represent a smaller percentage of government revenue than in the 1940s. Personal income taxes, on the other hand, make up a larger proportion of government revenue than before. (Image: adapted from nationalpriorities.org)

There are also state income taxes that companies are liable to pay.

PriceWaterhouseCoopers makes says that in the US, resident companies have to pay tax on their global income.

Tax-free corporate events

Some corporate events in the United States are tax-free. In other words, in those events, companies do not have to pay tax. In most cases, state regulations are similar to federal ones.

Formation

The formation of a company by controlling corporate or non-corporate shareholders is a tax-free event. When these tax-free formations occur, the owners transfer the tax attributes of assets and liabilities to the new business entity.

Imagine that Paul and Jane, two US residents, operate a window-cleaning business as a partnership. They want to set it up as a limited liability company and call it Paul-Jane Windows Cleaning LLC.

They transfer assets of the business to Paul-Jane Window Cleaning LLC, a new California company. Paul and Jane are the sole shareholders.

The transfer of money, etc. to the new company should not cause gain or loss for any party. In other words, the new company should not cause Jane, Paul, and the new company gain or loss.

The whole process of setting up Paul-Jane Windows LLC is tax-free.

Acquisitions

When one company acquires another, it is a non-taxable event. It is non-taxable not just for the two companies, but also their shareholders. The same applies to mergers.

Reorganizations

Businesses can change key aspects of their capitalization, structure, or legal identity in a tax-free manner. Examples include liquidations of subsidiaries, mergers, exchange of shares for assets, and recapitalization. Changes in the form or place of the organization is also tax-free.

Giant companies paying less tax

Giant corporations in the US today pay a smaller share of federal tax revenue compared to sixty years ago. In the 1950s, they represented one-third of total revenue. Today, however, they represent just one-tenth, according to Americans for TaxFairness.

Americans for TaxFairness says that lobbyists are misleading us when they quote America’s high corporate tax rate.

Lobbyists focus on the top statutory rate rather than the effective tax rate. In other words, they tell us what the law says rather than what actually happens.

Americans for TaxFairness says:

“Corporations haven’t contributed a dime towards deficit reduction in recent budget deals. And they want to continue this special treatment while American families shoulder the entire burden.”

What should governments do if they want to stop companies moving money into offshore financial centers? Some people believe they should lower tax rates.

Video – corporate income tax return

This Free Legal Forms video explains how to fill in the Form 1120 US Corporation Income Tax Return.