A corporation that doesn’t qualify as an S corporation or that doesn’t elect this alternative if it does qualify, is referred to as a C corporation in the tax law.
A C corporation is subject to federal income tax based on its taxable income for the year, keeping in mind that a host of special tax credits (offsets) could reduce or even eliminate the amount of income tax a corporation has to pay. Suppose a business is taxed as a C corporation. Its abbreviated income statement for the year just ended is shown here.
Refer to the C corporation income statement. Based on its $2.2 million taxable income for the year, the business owes $748,000 income tax — assuming a 34 percent tax rate for this level of corporate taxable income. (Most of the annual income tax should have been paid in installments to the IRS before year-end.)
The income tax is a big chunk of the business’s hard-earned profit before income tax. Finally, don’t forget that net income means bottom-line profit after income tax expense.
Being a C corporation, the business pays $748,000 income tax on its profit before tax, which leaves $1,452,000 net income after income tax. Suppose the business distributes $500,000 of its after-tax profit to its stockholders as their just rewards for investing capital in the business.
The stockholders include the cash dividends as income in their individual income tax returns. Assuming that all the individual stockholders have to pay income tax on this additional layer of income, as a group they would pay $75,000 in income tax to Uncle Sam (based on a 15 percent rate on corporate dividends).
A business corporation isn’t legally required to distribute cash dividends, even when it reports a profit and has good cash flow from its operating activities. But paying zero cash dividends may not go over well with all the stockholders. If you’ve persuaded your Aunt Hilda and Uncle Harry to invest some of their money in your business, and if the business doesn’t pay any cash dividends, they may be very upset.