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How Corporations Are Taxed

Corporations are taxed in a different manner than other business entities. In fact, corporations are the only types of business that pay income taxes on their profits. Conversely, partnerships, sole proprietorships, and limited liability companies (LLCs) are not taxed on business profits. Rather, the business profits “pass through” to the business’ owners, who in turn report the business income (or losses) on their personal income tax returns.

Corporations are taxed separately from their individual owners. If a taxpayer’s business is not incorporated, all the profits from the business will be taxed on the taxpayer’s personal income tax return in the year that the profits were earned. Incorporating such a business may prove to be a good way to save on taxes, especially if the taxpayer intends to reinvest the profits in the business. For example, if a taxpayer’s business is incorporated, the first $75,000 of the business’s profits will be taxed at a lower rate than if the taxpayer claimed them on his or her personal income tax return. However, there are exceptions: personal service corporations like legal, accounting, consulting, and medical groups must pay a flat tax rate of 35 percent on their taxable income.

Corporations can deduct employee benefits, such as health insurance, disability, and up to $50,000 in life insurance. This deduction applies to owners who are also employees of the company. The IRS permits incorporated businesses to treat their owners as employees for benefits purposes, allowing these owners to take the tax deduction on their own as well as their employees’ benefits. Conversely, owners of unincorporated businesses and sole-proprietorships cannot deduct their own benefits.

Taxpayers cannot immediately claim on their personal income tax corporate losses on their incorporated businesses. Rather, they must wait until they can offset their losses by profits. This is particularly problematic for newer businesses because most new businesses produce very little revenue in their first few years and losses are common.

Inside How Corporations Are Taxed