A corporate tax, or a corporation or company tax, is a specific type of fee that is imposed by the federal government on a business’s profits. According to the Federal Tax Cuts and Jobs Act of 2017, the current federal corporate tax rate is 21%. What this means is that after all business expenses have been deducted, a corporation will be required to pay the federal government 21% of its total revenue when filing a federal corporate tax return.
An example of this would be if after deducting all legitimate business expenses, your corporation made $1 million dollars in revenue. At the time that you file your business’s federal corporate tax return, you will owe 21% of that $1 million dollars in taxes to the federal government; or, $210,000.
It is important to note that the federal corporate tax rate is subject to change. Additionally, states may impose their own separate corporate income tax rates on top of the federal corporate tax. However, not every state applies a state corporate income tax rate, and those that do generally have rates that vary considerably based on jurisdiction. The standard range for state corporate income tax rates is between one and twelve percent, and most state rates average in the middle.
In continuing with the above example, if you live in a state that applies its own separate corporate income tax rate such as Kentucky, you will need to deduct both the federal and state tax amounts from your total revenue. Kentucky’s rate is 5%, so you would deduct $210,000 in federal taxes, and $50,000 in state taxes. As such, you will owe $260,000 in federal and state taxes, meaning that you will be left with $740,000 of your total profits.
A corporation may also need to pay taxes that are specific to certain divisions of a business. Some common types of corporate taxes that a business may have to pay include:
- Employment or Payroll Taxes: These taxes refer to the percentage that gets taken out of an employee’s paycheck. They may be used to pay off taxes, such as those for social security benefits and Medicare, or unemployment;
- Real Estate Taxes: Some businesses may be required to pay real estate taxes on property that it owns, such as if a corporation owns the building in which it operates;
- Estimated Taxes: A business may need to make installment payments on taxes periodically throughout a given tax year. This is generally required when a business expects to owe $500 or more in federal income taxes;
- Franchise Taxes: Some states implement a franchise tax on businesses that want to operate or remain open in their specific state; and/or
- Excise Taxes: Excise taxes are only applied to specific goods, such as alcohol, gasoline, cigarettes, some luxury goods, and other items that are regulated by various different tax laws.
What Is A Sham Business Transaction?
A business transaction is an interaction between a business and a:
- Vendor;
- Customer; or
- Another business.
The transaction may simply be buying or selling, or it could be something more complex. These transactions generate tax liability for the business.
A sham transaction is a type of business transaction done for the purpose of avoiding taxes on a profit. An example of this kind of transaction would be when a company buys stock for $800, and the dividend pays $200. Later, the company sells the stock for the market value of $800. The transaction appears to be a capital loss, but it is not. This is because the company waited until after it collected the $200 dividend to make the transaction; as such, the company made a $200 profit from the stock purchase.
The IRS will most likely deny the company’s claim for the withholding tax and capital losses. According to the IRS, the transaction was a sham; however, the company will contend that it only bought the right to make money from the dividend, and may challenge the IRS’s decision in court.
Some courts apply a two-prong test to a transaction in order to ensure that the transaction is not a scam. The first step would be to determine whether the transaction has any economic benefit, or substance, other than creating a tax benefit. This step is referred to as the objective economic substance test.
The second step is called the subjective business purpose test, and it examines whether the transaction was motivated by a business purpose other than obtaining a tax benefit.
Other courts use a sham analysis test, which is based on whether the transaction had any economical benefit other than generating an income tax loss.
What Else Should I Know About Capital Assets?
A capital asset can be real property, such as a home or land, or personal property, such as jewels or artwork. Additionally, both businesses and individuals may own capital assets. Because the law taxes the sale of capital assets, when a person sells a capital asset at a price greater than the price that they paid for the asset, they have realized what the law calls capital gain.
The amount of profit, or capital gain, is taxed. Capital gains are considered to be part of a person’s income, and as such they are subject to a special tax that is known as the capital gains tax.
Capital losses can be deducted from one’s total taxable income, reducing the total tax bill. Currently, short-term capital losses can be used in order to offset those short-term capital gains made in a tax year. This allows a person to report a lower income number on their return. An example of this would be if for tax year 2020, a person has short-term capital gains of $2,000 and short-term capital losses of $5,000. They have a net capital loss of $3000 ($2000-$5000) and can subtract that figure from their total taxable income amount.
Under most circumstances, a person has no capital gains to offset a capital loss or losses. As such, capital losses may be subtracted from ordinary income. This amount may reach up to $3,000 worth of losses in one tax year.
Individuals may be able to reduce the amount of capital gains tax, or avoid payment of the tax entirely. One legal way to do this is to make investments on a long-term basis, rather than a short-term basis. Assets that are held for more than one year are generally taxed at a lower capital gains tax rate than are assets that are held for under one year.
Another legal method of reducing the amount of capital gains tax is to offset short-term capital gains with short-term capital losses. If the latter exceeds the former for a given year, a person has sustained a net capital loss, and they will not be taxed for capital gains because there are no gains to tax.
One other legal method of capital gains tax reduction is to enroll in a tax-deferred retirement plan. Retirement plans include those sponsored by an employer (such as a 401k) or plans in which a person sets up and manages the plan (or, an IRA). However, they must pay taxes on retirement plan investment income.
These taxes can be paid on a deferred basis, meaning that the taxes will be due only when money is taken out of the account upon reaching retirement age. As such, the money is not taxed immediately. Deferring taxation allows a person to accrue capital gains without having to pay taxes on those gains until retirement.
Do I Need A Lawyer If I Am Involved In A Sham Transaction?
If you are involved in a sham transaction, you will need to speak with a tax attorney immediately. An experienced business attorney can help you understand more about sham transactions, as well as any possible legal defenses.
