Avoiding Excessive Corporate Taxation
Income tax is a progressive system; it is designed to disproportionately tax wealthy individuals and businesses. As taxable net income increases, we find that both individuals and corporations are required to pay ever increasing marginal tax rates. The following information will help to understand how to avoid excessive corporate taxation.
In addition, all money earned through normal C corporations is taxed twice. First, the net income of the corporation is taxed by the federal government. Next, any money paid in salaries and wages counts as taxable income for the individual employees. Finally dividends paid to investors, and money earned by trading corporate securities is subject to income tax and capital gains tax, respectively.
What is a corporation to do? If not carefully planned and managed, those seeking to earn money through a C corporation could end up paying more than half their companies profits in taxes. Fortunately, there are a number of ways to make the complicated corporate tax system work in your favor.
In this article, we will explore several clever ways in which a C corporation can pay its employees and investors while avoiding paying excessive corporate taxes.
By strategically planning salary payments, a C corporation can take advantage of the double taxation of corporate profits. Since marginal tax rates are lowest when
For example, if a C corporation earns $100,000 in net income it will have a high marginal tax rate. An individual business owner (sole proprietorship) who earns the same $100,000 will also experience a high marginal tax rate. In contrast, a C corporation that pays $50,000 to its owner as a salary, and keeps the other $50,000 as corporate profits will benefit from much lower tax rates. In this case, both the owner and corporation will find themselves in the lowest tax brackets, and both will pay much less income tax.
Since salaries count as an expense, they can be used to shift income from the corporation to employees and owners in such a way that both the corporation and people receiving payments enjoy lower marginal tax rates.
The downside of paying salaries is, of course, payroll tax. In the United States, payroll tax includes payments to social security, Medicare, and unemployment. Collectively, these taxes usually amount to about 10-15% of the salary paid. There are two ways, however, that corporations can get around the payroll tax – fringe benefits and independent contractors.
Retirement packages, expense accounts, health care and other insurance is another way to pay employees while avoiding excessive taxes. Most employees would probably pay for these services anyways, and since they are not paid out as salary, they count as expenses for the corporation, while avoiding the payroll tax.
Since independent contractors are not considered company employees, payments to these individuals are not subject to the payroll tax. Someone who works full-time for an extended period cannot be considered an independent contractor, however.