The Corporate Taxation - Essay Example

Corporate Taxation Introduction A corporation is defined as a legal entity that is distinct. This definition enables a corporation to do business, open and run bank accounts, and own property using its legally recognized name. The general affairs and weighty business decisions of a corporation are managed and sighted by a board of directors, which consists of individuals who are nominated or elected by the majority of shareholders of the company. After the election or instituting of a board of directors, the board is tasked with responsibility of appointing or employing officers to run the corporation on a daily basis. A corporation is structured in a way that its shareholders and stockholders are not held liable for any debts that the corporation may accrue. This fact protects a corporation’s shareholders from legal action or liability because of the identity of a corporation as a legal entity, for example, if a company defaults or slips into bankruptcy, the debtors will go after the company’s assets in order to recover their debt. If the company’s assets are not enough to cover the debt, legally the debtors cannot go after the directors, officers, or shareholders personal assets in order to recover their debts. This is the primary advantage of a corporation. C and S Corporations There are many types of corporations, but in terms of taxation, there are two types of corporations. The two types refer to the special types of tax categories or elections recognized by the internal revenue authority. The two types of corporations are C and S corporations, and they have different advantages and disadvantages, and formulation processes. The formulation process of both types of corporations is similar, and it starts with filing at the state level before proceeding to the IRS. The structures between the two types of corporations are similar, and the two share a number of characteristics such as allowing shareholders, directors, and officers to separate their personal assets from corporation assets. The major difference between the two types of corporations is the taxing system attached to each. The taxation regime applied on S corporations sets many restrictions to the shareholders compared to shareholders of C corporations (Block 56). C Corporation Taxation This election of corporations includes all the publicly traded or listed companies. It is the most common structure of a company found in the United States. This corporation is recognized as a separate legal entity, and shareholders’ own it. A C Corporation does not have a maximum number of shareholders because of its independent legal nature; it is an independent legal entity, therefore, entitled to an unlimited number of shareholders. The nature of the corporation limits the liability of each shareholder to the amount of investment committed to the corporation. The legal nature of a C corporation and the structure of its formulation allow application of different tax laws compared to an S Corporation. Revenue or income generated by such a corporation is taxed at the corporate tax level rates as directed by the corporate income tax levels stipulated by the Internal revenue Authority. After taxation at the income tax level, any distribution in the form of dividends to shareholders is subjected to taxation at shareholder tax rates. Another advantage of C corporations in terms of taxation is the fact that salaries may offset income tax. Salaries paid at the corporate level are not subject to corporate income tax deductions, but the recipients are subjected to income tax, and FICA tax. This nature of taxation loopholes enjoyed by such corporations may result in the corporate evading paying corporate taxes because the net profit may be converted to salaries to shareholders or owners. Accumulation of earnings after corporate level taxation is not taxed as in the case of S corporations. The profits will only be taxed when they handed out to shareholders in the form of dividends. However, a corporate risks facing accumulated tax earnings of 40% and the regular corporate tax deductions. S Corporation Taxation As stated earlier, an S corporation is a creation of the federal tax laws. To form an S Corporation, it must be incorporated at under the state law followed by electing for taxation as a partnership business by filing an application to the IRS. This application to be taxed as a partnership keeps the preservation of the corporation by not facing corporate taxation, while maintaining its limited liability provided under the state law. This tax election of an S corporation means that losses and profits are passed to the shareholders just like a partnership business. The significant between this form of the corporation and a partnership is that all profits, income, losses or other liability are passed to the shareholders and allocated on the basis of each shareholder’s stock value, for example, if a shareholder owns 20% of the corporate’s stock, 20% of all profits, income, losses, and other liabilities are passed to him. This is in contrast to partnerships in which a member receives different percentages as per to the specifics of the agreement (Block 24). The tax laws applied to S corporation do not limit such a corporation to the status of a small business, but the requirements of such a taxation regime can make it hard to operate a business that can be defined as a large. Under the United States tax laws, an S Corporation must fulfill the following requirements in order to be operational: 1. The corporation must be based in the United States; it must be domestic organized and formed on a territory that is under the taxation laws of the United States 2. The total number of shareholders should not exceed 100 3. An election in which all the shareholders agree to participate must be carried out 4. All the corporations shareholders should be citizens of the United States, and should not be other legal entities such as other corporations 5. An S corporation is allowed to hold an 80% stock in a C corporation in which the C Corporation can file a consolidated return, but the S corporate is not allowed 6. The corporation must not have more than one class of stock. However, nonvoting and voting are considered as one class under the IRS tax laws Tax Advantages of Corporations Income shifting: Under the tax laws, C Corporations undergo double taxation, but they also provide high tax flexibility through using income shifting to avoid taxation if they are in the low-income bracket. Business losses: Incorporated entities are subjected to less stringent measures regarding to corporate losses in comparison to unincorporated businesses. A corporation is not limited or restricted on the amount of losses or profits accrued during operation. In addition, a corporation may carry or transfer its taxes or losses to previous or forward years. Unincorporated entities do not enjoy these privileges available to corporate businesses. Fringe benefits to officers: Corporates offer greater retirement, medical cover plan, and life insurance covers compared to unincorporated entities. These benefits make it easy for corporations to attract effective executives who drive the company’s revenue and profile. Leasing of assets: Shareholders are allowed to lease their assets to the corporate, and this is used to avoid tax liability. Shareholders claim rental income from leased assets while the corporation pays the lease fee allowing a shareholder to deduct insurance, administrative, and depreciation costs. Tax savings: In corporations self –employment tax deductions are made on salaries and not profits as is the case in sole proprietorships. This saves corporations a lot of money in the form of deductions made towards meeting self-employment tax requirements. In conclusion, corporate taxation models save corporate businesses a lot of money in terms of potential tax benefits. Work cited Block, C. D. Corporate Taxation: Examples and Explanations. New York: Aspen Publishers Online, 2004. Print Read More