They say that you should never handle a gun before reading the instruction manual. The same goes for owning stock in a corporation. You must understand how they work.
|Before handling, read the instructions.
S&W 629-1 3″ by ~Steve Z~, on Flickr
The following discussion only applies to Subchapter-C corporations. Corporations may elect something called Subchapter-S status, which completely changes all of the rules. I plan to explain taxation of Subchapter-C corporations in a future post.
Corporate tax rates range anywhere from 15% to 38%. Like individuals, corporations follow the “pay as you go” system, and must pay estimated taxes each quarter, and then file a year-end tax return (Form 1120), which computes income, income taxes due, and any additional payments required or refund owed.
- Corporations pay their own income taxes on taxable income.
- Taxable income, when distributed as dividends to owners, is usually taxable as income to the owners. (Dividends are payments of profits to a corporation’s stockholders.)
Small business corporations often work around these rules by paying stockholders salary instead of dividends. The corporation is permitted to record this salary as an expense, so that it decreases taxable income and income tax expense. Like any other salary, this income is subject to social security and medicare taxes.Some small business corporations attempt to work around these rules by paying personal expenses of their owner, such as the cost of a car lease. This strategy doesn’t work very well because the tax authorities consider such “employee benefits” to be taxable income to the owners, just like salary.
Another way to avoid double-taxation is to simply let a corporation keep its own profits, not paying any dividends at all to stockholders. However, this strategy may not be practical for many stockholders, who, you know, are in business to make money.
Another strategy is to elect something called Subchapter-S status. I’ll explain this in a future post.
* 10,000 – (10,000 x 35%) = $6,500