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  • Writer's pictureAntonise De Wet

How does the corporate tax work?




In the midst of constitutional challenges, the first federal income tax was enacted in 1861 and ended in 1872. In 1894, a corporate income tax was passed; however, a crucial part of it was soon ruled unconstitutional. Congress passed an income-based excise tax on corporations in 1909. This became the corporate provisions of the federal income tax following the ratification of the sixteenth amendment to the United States Constitution. Since then, the majority or all revenue acts have included modifications to various provisions that affect corporations. Title 26 of the United States Code, also known as the Internal Revenue Code, contains provisions relating to corporate taxes. The Tax Reform Act of 1986 adopted the current corporate income tax rate.


A corporation's receipts less allowable deductions, such as cost of goods sold, wages and other employee compensation, interest, the majority of other taxes, depreciation, and advertising, result in taxable corporate profits. Foreign multinational corporations that own US-based corporations are typically subject to the same US corporate tax regulations as US-owned corporations with regard to their profits from US business activities.


With the passage of US tax reform legislation on December 22, 2017 (P.L. 115-97), the country transitioned from a "worldwide" system of taxation to a "territorial" system. P.L. 115-97, among other things, reduced the resident corporation CIT rate from 35% to a flat rate of 21% for tax years starting after December 31, 2017.


The amount and nature of a non-US person's presence in the US will determine how much of their income is taxed in the US and whether it has a connection to the US.


CURRENT CORPORATE INCOME TAX CHANGES:

The top corporate income tax rate was lowered from 35% to 21% under the Tax Cuts and Jobs Act (TCJA), which also did away with the corporate AMT and graduated corporate rate schedule. The TCJA permits full expensing of the majority of new investments through 2022; following that, this benefit is phased out through 2026. Net interest expense deductions were also restricted by the TCJA to 30 percent of adjusted taxable income.


The way multinational corporations and their foreign-sourced income were handled was fundamentally altered by the TCJA. Prior to the TCJA, a system known as the "worldwide" system applied US tax with a credit for foreign income taxes paid to dividends distributed by foreign subsidiaries to their US parent corporations. A so-called "territorial" system currently exempts a ten percent return on a certain qualified business asset investment from additional U.S. tax. Returns above that amount, however, are subject to the reduced-rate Global Intangible Low-Taxed Income (GILTI) minimum tax regardless of whether they are repatriated as dividends. The Base Erosion and Anti-Abuse Tax (BEAT), another new domestic minimum tax introduced by the TCJA, is intended to stop cross-border profit shifting.


TAXES AT THE SHAREHOLDER LEVEL

Dividends and capital gains from the sale of shares are two ways that corporate profits may be taxed again at the individual shareholder level. Dividends are divided into "qualifying dividends," which include the majority of ordinary dividends paid by U.S. corporations, and other dividends, while capital gains are divided into long-term and short-term categories depending on how long an asset has been held. The maximum tax rate on qualifying dividends and long-term capital gains is currently 23.8 percent, while the maximum tax rate on non-qualifying dividends and short-term capital gains is currently up to 40.8 percent (the top marginal rate of individual income tax of 37 percent plus the 3.8 percent tax on net investment income).


Although many US businesses are taxed as "pass-through" entities, they are not all subject to the corporate income tax. Pass-through companies are exempt from entity-level taxes. However, under the individual income tax, their owners are required to include their allotted portion of the businesses' profits in their taxable income. Limited liability companies (LLCs), partnerships, sole proprietorships, and S-corporations are examples of pass-through entities.


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