Corporations are a separate entity under the law and as such are subject to taxation at both the state and Federal levels. In general corporations are subject to Federal income tax on the annual profits in many ways similar to the tax on individual income. However, there are significant differences.
The most important aspect is the “double” taxation on corporate income if it is distributed to the shareholders in the form of dividends. At the corporate level, corporate net income is subject to tax at the corporate level. Corporate funds that are distributed to officers or directors in the form of salaries, expense reimbursements, or employee benefits may be used by a corporation as a legitimate business deduction against the income of the corporation. Corporate surplus funds that are paid out to shareholders in the form of dividends on their ownership of stock in the corporation, however, are not allowed to be used as a corporate deduction. Thus, any funds used in this manner have been subject to corporate income tax prior to distribution to the shareholders. The dividends are then also subject to taxation as income to the individual shareholder and so are subject to a “double” taxation.
S-corporations are taxed similarly to partnerships, with the corporation acting only as a conduit and all of the deductions and income passing to the individual shareholders where they are subject to income tax. Standard corporations, however, may be used by businesses in many ways to actually lessen the federal and state income tax burdens. A competent tax professional should be consulted. A brief study of the Federal tax forms your business will use will provide you with an overview of the method by which corporations are taxed. The financial records that you will compile will make your tax preparation much easier, whether you handle this yourself or it is handled by a tax professional. A basic comprehension of the information required on Federal tax forms will help you under¬stand why certain financial records are necessary. Understanding tax reporting will also assist you as you decide how to organize your business financial records.
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