What is corporate tax? Definition and meaning
Corporate tax, also known as corporate income tax, is a levy that governments collect on the profits of their resident commercial enterprises. This type of taxation is known corporation tax in the UK and Ireland and company tax in Australia. It is a major source of government revenue, typically the third largest – after individual income tax and payroll taxes.
In the United States in fiscal 2014, the federal government raised $320.7 billion in corporate taxes, its third largest source of income. However, over the past half century, it has been declining as a proportion of total government income.
The company calculates its operating earnings by deducting expenses including COGS (cost of goods sold) and depreciation from revenues. Corporate tax is paid according to how much profit is made. In some countries there is a flat rate, while in others there is a sliding scale, i.e. the percentage of the total paid in taxes rises as profits get bigger.
These are the corporate tax rates that the Federal Government levies on companies’ profits. Add to this the taxes charged by individual States.
US has highest corporate tax rate
Rules governing corporate taxation vary considerably from country to country. Among the advanced economies, the Unites States – at 40% – has the highest rate of corporate tax (consisting of the 35% federal rate and a combined state rate). In the UK and Ireland, for example, corporate taxation rates are 20% and 15% respectively.
In the United States, corporate tax returns are usually due in by March 5th each year. Commercial enterprises may request a 6-month extension to have tax returns due in September. Companies whose assets exceeds $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, except for partnerships, which file an information return. Which form is used depends on how the business is organized, which is explained in the IRS’ Business Structures section.
In most countries, companies based abroad are only taxed on the profits they make from their business activities within the country, if they have an office or branch in that country.
How come corporate tax rates have increased in the USA but represent a much smaller percentage of total federal revenue today compared to the 1940s? Personal income taxes on the other hand, make up a much larger proportion of total revenue for the government than they used to. (Image: adapted from nationalpriorities.org)
Domestic companies that are subject to foreign corporate taxes are usually granted a foreign tax credit for such taxes.
Corporate tax history in the US
The first US federal income tax was enacted in 1861 – amid constitutional challenges it expired in 1872. In 1894, a corporate income tax was enacted. However, it soon became deemed 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 the federal income tax.
Since then, there have been many amendments to US corporate taxation codes within the IRS. The current rate of tax was adopted in the 1986 Tax Reform Act. By 2010, 9% (1.3% of gross domestic product) of all federal revenues came from corporate tax, compared to 32% in 1952.
Today, federal corporate taxation rates in the US range from 15% to 35%. A company with a taxable income greater than $18,333,333 pays 35%, while a commercial enterprise with a taxable income of up to $50,000 pays 15%. There are also state income taxes that companies are liable to pay.
PriceWaterhouseCoopers makes says the following regarding US corporate taxes:
“In the United States, resident corporations are taxed based on worldwide income. Generally, a foreign corporation engaged in a US trade or business is taxed at regular US corporate tax rates on income from US sources that is effectively connected with that business and at 30% on US-source income not effectively connected with that business.”
Non-taxable corporate events
Some corporate events in the United States are tax-free as far as corporations or shareholders are concerned. In most cases, state regulations are similar to federal ones.
– Formation: the formation of a company by controlling corporate or non-corporate shareholders is usually a tax-free event. When these tax-free formations occur, the tax attributes of assets and liabilities are transferred to the new business entity.
Imagine that Paul and Jane, two US residents, operate a window-cleaning business as a partnership. They now want to set it up as a limited liability company called Paul-Jane Windows Cleaning LLC. They transfer assets of the business to Paul-Jane Window Cleaning LLC, a newly-formed California company, of which they are the sole shareholders.
The transfer of money, etc. to the newly-formed company should not generally cause gain or loss for Jane, Paul or the new company. The whole process of setting up Paul-Jane Windows LLC is tax-free.
Acquisitions: when one company acquires another company or merges with it, the whole event is treated as non-taxable for both companies as well as their shareholders.
Reorganizations: commercial enterprises 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, recapitalization, and changes in the form or place of organization.
Giant companies paying less tax
Giant corporations in the United States today pay a smaller share of federal tax revenue compared to sixty years ago, declining from one-third of the total in the 1950s to just one-tenth today, according to Americans for TaxFairness.
Americans for TaxFairness says that lobbyists, who want Congress to reduce corporate tax rates, are misleading lawmakers, the press and the general public when they quote the country’s comparatively high corporate tax rates. They focus on the top statutory rate rather than the effective tax rate, i.e. 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. Meanwhile, the country is starved for resources needed to foster economic growth and job creation – from infrastructure to research to improved schools.”
Some key facts:
– In 1952, thirty-two percent of federal tax revenue came from corporate tax. By 2013 this proportion fell to 10%.
– Verizon, Boeing, General Electric and twenty-three other highly-profitable Fortune 500 companies paid absolutely no federal income taxes from 2008 to 2012.
– From 2008 to 2012, 288 large and profitable Fortune 500 companies paid an average effective federal tax rate of only 19.4%.
– In 2010, profitable companies paid US corporate taxes amounted to just 12.6% of global income in 2010.
– A total of $90 billion is placed in **tax havens around the world in order to dodge taxes. American corporations hold $2.1 trillion in profits offshore.
** Tax havens are countries, territories, or parts of countries where taxes are considerably lower than anywhere else. They attract money from companies and individuals who want to pay less tax.
The most effective way to stop people and companies in your country from moving their money and investments into offshore financial centers is to lower domestic tax rates.
Video – US corporate income tax return
This Free Legal Forms video explains how to fill in the Form 1120 US Corporation Income Tax Return.