Income Tax Features of C Corporations - dummies

Income Tax Features of C Corporations

A C corporation is a business entity that is subject to federal income tax based on its taxable income for the year. A corporation that cannot qualify as an S corporation — or that does not elect this alternative if it does qualify — is referred to as a C corporation in the tax law.

There are a host of special tax credits (offsets) that 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 as follows:

Abbreviated Annual Income Statement for a C Corporation
Sales revenue $26,000,000
Expenses, except income tax (23,800,000)
Earnings before income tax $2,200,000
Income tax (748,000)
Net income $1,452,000

Given the complexity and changing nature of the income tax law, the following discussion avoids going into details about income tax form numbers and the income tax rates used to determine the income tax amounts in each example.

Refer to the C corporation income statement example in the table above. Based on its $2.2 million taxable income for the year, the business owes $748,000 income tax — most of which should have been paid to the IRS before year-end. The income tax is a big chunk of the business’s hard-earned profit before income tax. The net income figure is 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 something in the neighborhood of $75,000 income tax to Uncle Sam.

A business corporation is not 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 down well with all the stockholders. The average large public corporation pays out about 30 percent of its after-tax annual net income as cash dividends to its stockholders.