Corporate tax in the United States
Corporate tax is imposed in the United States at the federal, most state, and some local levels on the income of entities treated for tax purposes as corporations. Since January 1, 2018, the nominal federal corporate tax rate in the United States of America is a flat 21% following the passage of the Tax Cuts and Jobs Act of 2017. State and local taxes and rules vary by jurisdiction, though many are based on federal concepts and definitions. Taxable income may differ from book income both as to timing of income and tax deductions and as to what is taxable. The corporate Alternative Minimum Tax was also eliminated by the 2017 reform, but some states have alternative taxes. Like individuals, corporations must file tax returns every year. They must make quarterly estimated tax payments. Groups of corporations controlled by the same owners may file a consolidated return.
Some corporate transactions are not taxable. These include most formations and some types of mergers, acquisitions, and liquidations. Shareholders of a corporation are taxed on dividends distributed by the corporation. Corporations may be subject to foreign income taxes, and may be granted a foreign tax credit for such taxes. Shareholders of most corporations are not taxed directly on corporate income, but must pay tax on dividends paid by the corporation. However, shareholders of S corporations and mutual funds are taxed currently on corporate income, and do not pay tax on dividends.
In 2021 President Biden proposed that Congress raise the corporate rate from 21% to 28%.[1]
Business entities may elect to be treated as corporations taxed at the entity and member levels or as "flow through" entities taxed only at the member level. However, entities organized as corporations under U.S. state laws and certain foreign entities are treated, per se, as corporations, with no optional election. The Internal Revenue Service issued the so-called "check-the-box" regulations in 1997 under which entities may make such choice by filing Form 8832.[18] Absent such election, default classifications for domestic and foreign business entities, combined with voluntary entity elections to opt out of the default classifications (except in the case of "per se corporations" (as defined below)).[19] If an entity not treated as a corporation has more than one equity owner and at least one equity owner does not have limited liability (e.g., a general partner), it will be classified as a partnership (i.e., a pass-through), and if the entity has a single equity owner and the single owner does not have limited liability protection, it will be treated as a disregarded entity (i.e., a pass-through).
Some entities treated as corporations may make other elections that enable corporate income to be taxed only at the shareholder level, and not at the corporate level. Such entities are treated similarly to partnerships. The income of the entity is not taxed at the corporate level, and the members must pay tax on their share of the entity's income. These include:
Corporate tax rates[edit]
Federal tax rates[edit]
The top corporate tax rate in the U.S. fell from a high of 53% in 1942 to a maximum of 38% in 1993, which remained in effect until 2018, although corporations in the top bracket were taxed at a rate of 35% between 1993 and 2017.[31]
After the passage of the Tax Cuts and Jobs Act, on December 20, 2017, the corporate tax rate changed to a flat 21%, starting January 1, 2018.[32]
Tax credits[edit]
Corporations, like other businesses, may be eligible for various tax credits which reduce federal, state or local income tax.[36] The largest of these by dollar volume is the federal foreign tax credit.[37][38] This credit is allowed to all taxpayers for income taxes paid to foreign countries. The credit is limited to that part of federal income tax before other credits generated by foreign source taxable income. The credit is intended to mitigate taxation of the same income to the same taxpayer by two or more countries, and has been a feature of the U.S. system since 1918. Other credits include credits for certain wage payments, credits for investments in certain types of assets including certain motor vehicles, credits for use of alternative fuels and off-highway vehicle use, natural resource related credits, and others. See, e.g., the Research & Experimentation Tax Credit.
Corporate tax avoidance and corruption[edit]
Corporate tax avoidance refers to the use of legal means to reduce the income tax payable by a firm. One of the many possible ways to take advantage of this method is by claiming as many credits and deductions as possible.[48]
An empirical study shows that state-level corruption and corporate tax avoidance in the United States are positively related. According to the average effect of an increase in the number of corporate corruption convictions, it is observed that state-level corruption reduces Generally Accepted Accounting Principles (GAAP) tax expense.[49]
The main occurrence of corruption and corporate tax avoidance was in states that had the lowest level of litigation risk despite their ranking in social capital, money laundering and corporate governance. Hence, strengthening law enforcement would definitely control the level of corruption caused by tax avoidance. Corruption is distinct from earnings management predictions, disclosure of accounting restatements as proof of fraudulent accounting and tax accruals quality. Corruption metrics show that firms with their headquarters in a state with a high level of corruption are more likely to participate in tax evasion.[50]
According to research on culture and tax evasion, corruption can be caused by increased organizational, financial and legal complexity and the same factors can influence a firm's chance of engaging in corporate tax avoidance.[51]
Earnings and profits[edit]
U.S. corporations are permitted to distribute amounts in excess of earnings under the laws of most states under which they may be organized. A distribution by a corporation to shareholders is treated as a dividend to the extent of earnings and profits (E&P), a tax concept similar to retained earnings.[66] E&P is current taxable income, with significant adjustments, plus prior E&P reduced by distributions of E&P. Adjustments include depreciation differences under MACRS, add-back of most tax exempt income, and deduction of many non-deductible expenses (e.g., 50% of meals and entertainment).[67] Corporate distributions in excess of E&P are generally treated as a return of capital to the shareholders.[68]
Liquidation[edit]
The liquidation of a corporation is generally treated as an exchange of a capital asset under the Internal Revenue Code. If a shareholder bought stock for $300 and receives $500 worth of property from a corporation in a liquidation, that shareholder would recognize a capital gain of $200. An exception is when a parent corporation liquidates a subsidiary, which is tax-free so long as the parent owns more than 80% of the subsidiary. There are certain anti-abuse rules to avoid the engineering of losses in corporate liquidations.[69]
Foreign corporation branches[edit]
The United States taxes foreign (i.e., non-U.S.) corporations differently than domestic corporations.[70] Foreign corporations generally are taxed only on business income when the income is effectively connected with the conduct of a U.S. trade or business (i.e., in a branch). This tax is imposed at the same rate as the tax on business income of a resident corporation.[71]
The U.S. also imposes a branch profits tax on foreign corporations with a U.S. branch, to mimic the dividend withholding tax which would be payable if the business was conducted in a U.S. subsidiary corporation and profits were remitted to the foreign parent as dividends. The branch profits tax is imposed at the time profits are remitted or deemed remitted outside the U.S.[72]
In addition, foreign corporations are subject to withholding tax at 30% on dividends, interest, royalties, and certain other income. Tax treaties may reduce or eliminate this tax. This tax applies to a "dividend equivalent amount," which is the corporation's effectively connected earnings and profits for the year, less investments the corporation makes in its U.S. assets (money and adjusted bases of property connected with the conduct of a U.S. trade or business). The tax is imposed even if there is no distribution.
Standard tax texts
Treatises