How Are C Corporations Taxed?
One question we hear often is, “How are C Corporations taxed?”
So, we thought we’d answer it.
How Are C Corporations Taxed?
Looked at narrowly, that question has a very simple answer:
- A C Corporation, as a tax paying entity, pays income tax on its net profits (taking into account revenue, cost of goods sold, deductible business expenses, etc.) at a current federal rate of 21%, plus applicable state income taxes. Period.
How Are the Profits Taxed?
But, if we reframe the question as, “How are a C Corporation’s profits taxed?” the answer becomes more complicated.
- Any corporation is an entity owned by its shareholders, whether there is a single shareholders or thousands.
- A C Corporation may make distributions of some or all of its profits to its shareholders in the form of dividends.
- The C Corporation’s dividends are paid in after tax dollars.
- These dividends are taxable to the shareholder(s).
- Most such dividends are “qualified,” meaning they generate income tax liability at a rate usually lower than the individual income tax rate appliable to the shareholder – qualified dividends are taxable at federal rates of 0%, 15%, and 20%, depending on household income.
- Important: though they are taxed at similar rates, dividends are not capital gains.
A C Corporation’s profits, therefore, are taxed first at the corporate level and again at the individual shareholder level when distributed.
Example
Let’s say ABC Corporation has 10 shareholders with equal amounts invested. It began tax year 2022 with healthy balances in their operating and savings accounts. The corporation generated $3.5 million in gross revenue in 2022. We will assume a state corporate income tax rate of 5%.
| ABC Corporation 2022 Revenue | $3,500,000 |
| 2022 Cost of Goods Sold | 1,400,000 |
| ABC Corporation 2022 Gross Profit | (revenue – cost of goods sold) 2,100,000 |
| Expenses | 1,100,000 |
| ABC 2022 Net Profit / Taxable Income | $1,000,000 |
| 2022 Federal Income Tax Liability – 21% | $210,000 |
| 2022 State Income Tax Liability – 5% | $50,000 |
| ABC 2022 Profit After Taxes | (net profit – federal & state tax liabilities) $740,000 |
ABC Corporation, its bank balances still comfortable, decided to distribute all its 2022 after-tax profits to its shareholders, in equal amounts of $74,000. We will assume that these distributions:
- represented qualified dividends, and
- that all shareholders fell into the income bracket paying 15% in federal income tax, and 6% in state income tax, on such dividends.
| Per-shareholder 2022 dividend distribution | $74,000 |
| 2022 Federal Income Tax Liability – 15% | 11,100 |
| 2022 State Income Tax Liability – 6% | 4,440 |
| Per-shareholder 2022 dividend after taxes | (distribution – federal & state tax liabilities) $58,460 |
| Aggregate 2022 distributions | $740,000 |
| 2022 Federal Income Tax Liability – 15% | 111,000 |
| 2022 State Income Tax Liability – 6% | 44,400 |
| Aggregate 2022 dividends after taxes | (distributions – federal & state tax liabilities) $584,600 |
So, on 2022 net profits of $1,000,000, ABC Corporation and its shareholders paid a combined rate of over 41% in federal and state income taxes.
We strongly urge you to consult with your virtual CFO or financial advisor to help you plan for minimizing your income tax liabilities.
Please click here to email us directly – let us know how we can help.
Until next time –
Peace,
Eric
Want to learn more? Check out our prior posts concerning C Corporations:
C Corp to S Corp Conversion – Is It Right For Your Business?