When it comes to taxation C corps, the first thing that you need to know is that they are subject to double taxation – while the profits earned by C corps are taxed at the corporate level, the profits distributed as dividends are taxed at the individual level. This is one of the major differences between C corps and other business entities such as S corps, LLCs, and partnerships, which are taxed (income tax) only at the individual level.
Corporations have to pay income tax on the profits after all other expenses are paid. However, the profits or earnings retained by C corps for investment purposes aren’t subject to taxation.
What Exactly Are Retained Earnings?
Every year, C corps pay off their debts and bills from the profits they make and distribute a certain portion of that profit among their shareholders and owners. However, C corps do not give away every penny of the profit that they make. So, what do they do with the rest of the profits? They retain this earning to reinvest in their businesses. This is known as retained earnings of C corps.
Retained earnings are usually kept in a separate account and are tax-exempt. And while salaries and bonuses are tax deductible (taxed at an individual level), dividends cannot be deducted. These saved funds are entered into a corporation’s balance sheet as stockholder’s equity.
These retained earnings are used for funding various requirements for the company from time to time such as purchasing business equipment, acquiring another company, paying debts, paying insurance premiums, expanding business operations, and so on.
Corporations retain earnings for other purposes too. For instance, sometimes shareholders of a corporation incline towards retaining a portion of the profits earned to avoid or minimize income tax. Also, as the retained funds keep growing, the value of the company stocks also increases. So, the shareholders can sell the stocks at a much higher price in the future. But this move is not always a welcome move – when a corporation retains a significant portion of its profits solely for the purpose of avoiding income tax, the IRS may impose a penalty tax or a personal holding company tax on it. To avoid this unsavory situation, it’s best that companies distribute a specific amount of their dividends within three months time from when the tax year in question ended.
How Are Retained Earnings Reported?
Every quarter, corporations are required to publish a quarterly income statement that shows the costs, revenues, taxes, and interests incurred during that quarter. The balance displayed on this sheet is the net income for the quarter and is regarded as the accumulated retained earnings for the same.
In the same manner, the annual report discloses the entire year’s retained earnings.
What Is Accumulated Earnings Tax?
When a corporation has not earmarked its retained earnings for a particular business purpose, they are subject to the accumulated retained earnings tax by the IRS. The accumulated earnings tax, however, applies to only private and public corporations without affecting personal holding companies and PFICs (Passive Foreign Investment Companies).
The ceiling for the accumulated retained earnings for C corps has been set at $2,50,000. C corps that exceed this amount are subject to a 20% tax on the funds that exceed $2,50,000.
If you have any further questions about C corps, talk to our tax experts at MyTaxFiler. You can write to us at email@example.com or call us at 1-(888)-482-0279 today!