If you’re a small-business owner, you’ll need to understand corporate income tax, even if you aren’t technically a corporation. You’ll need to pay it, since it’s an income tax levied by federal and some state governments on the profits of all businesses, regardless of size.
As part of the US tax code, of course, things can get complicated rather quickly—particularly for ecommerce businesses that operate across state lines. And some types of businesses are exempt from paying corporate income tax.
What is corporate income tax?
Corporate income taxes are taxes on a business’s profits, also known as net income. This is what’s left after subtracting the following expenses from a business’s revenue: cost of goods sold (COGS), rent payments, marketing, development, payroll, and other expenses broadly known as selling, general, and administration (SG&A).
In the US, the federal corporate income tax rate is a flat 21%. That’s been the rate since 2018, when the Tax and Jobs Act of 2017 lowered federal corporate income taxes from 35%.
On the state level, it’s more complex, since each can set its own state corporate income tax rate on a business’s taxable income. Some states don’t levy any tax on business income, while others impose a flat rate that works the same way as the federal income tax, and still other states have graduated rates that increase as a business’s profits rise. Several states also offer special exemptions and credits to help businesses reduce their corporate tax rate.
What’s more, states have varying definitions of a business’s nexus, or a connection to the state, which dictates whether the business has tax liability there. Often, this includes operating physically in the state with a headquarters, warehouse, distribution center, or other offices, but the tax law details can differ across state lines.
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How do corporate income taxes work?
What should ecommerce companies know about corporate tax, then?
For one, not all businesses are subject to federal or state corporate income tax. Several types of businesses are considered pass-through entities, in which the corporate profits (or losses) are passed on to the owners or shareholders, who then pay tax at their individual income tax rates.
Sole proprietorship income taxes
A sole proprietorship is a type of pass-through business that’s owned and operated by one individual. Sole proprietorships aren’t considered separate from the owner.
So if you’re running your business as a sole proprietorship or as a single-member limited liability company (LLC), your company’s corporate income is reported on your personal tax return and you’ll pay income tax at your individual rate (typically including self-employment tax). There’s no need to pay federal or state corporate income taxes.
Partnership income taxes
Business partnerships with two or more owners are another type of pass-through entity, and they work similarly to sole proprietorships. Partners report business income on their personal returns, and each person pays income taxes at their individual tax rates.
C corporation income taxes
A C corporation is not a pass-through entity. Instead, it’s what many people consider a traditional corporation: The company is legally separate from its owners or shareholders. This can protect personal assets and limit their liability if the company loses a court case or files for bankruptcy.
But the business pays income tax at the corporate level, and any money distributed to the owners or shareholders is taxed again at personal income rates. This is sometimes known as double taxation.
S corporations income taxes
S corporations are pass-through entities, thus avoiding double taxation. Similar to C corps, however, owners and shareholders are not personally liable for the company’s debts or obligations.
To receive the S corporation tax designation, a business must meet Internal Revenue Service (IRS) requirements, including status as a US domestic corporation, having only one class of stock, and having no more than 100 shareholders, among other things. When a business is an S corp, the income is passed through as with sole proprietorships and partnerships—that is, the owners or shareholders each pay income tax at their individual rates.
Many states require S corps to file annual or other periodic reports, and you may pay filing fees as well.
What to know about deductions
An individual or business can use deductions to lower their state and/or federal taxable income and reduce how much they pay in the tax year.
Owners of ecommerce companies, for example, can deduct expenses like the cost of goods sold, such as materials and labor costs that are directly involved in making products or services.
Other potential deductions include costs that aren’t directly involved in making your goods but are still necessary for running your business, including rent payments, advertising, utilities, employee salaries, and more. You may also be able to deduct some of the non-cash costs of certain assets that depreciate in value over a period of time, such as business equipment or company cars.
You can also potentially deduct your costs of giving your employees certain benefits, such as health insurance and retirement savings plans. Other possible deductions include interest paid on business loans and charity contributions. A tax professional can help you qualify for eligible deductions and explain exemptions, thresholds, and other guidelines.
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Corporate income taxes FAQ
Do LLCs pay corporate income taxes?
It depends. A limited liability company (LLC) owned by a sole proprietor or a partnership is what’s called a pass-through entity, meaning that any corporate profits or losses are passed on to the company’s owners, who then pay at their individual income tax rates. No income tax is levied at the corporate level.
However, an LLC may petition the IRS to be taxed as a corporation. It might do this if the switch would benefit its owners by lowering their personal tax bills. The company also must qualify for designation as a corporation.
Who pays the corporate income tax?
Businesses that are entities separate from their owners pay corporate income tax. The company pays a 21% rate on taxable corporate income to the federal government, plus any state corporate income taxes, depending on the state where the company operates.
What’s the difference between corporate tax and income tax?
Corporate tax usually refers to corporate income tax, which is levied by the federal and some state governments on a business’s profits. Meanwhile, “income tax” may refer to corporate income taxes or to the tax an individual pays on their personal income.
Is corporate income taxed twice?
Yes, in the case of corporations that are designated as entities separate from their owners or shareholders.
Entities such as sole proprietorships, partnerships, and S corps are not separate from their owners, so in those cases any corporate income is passed through to the owners who pay income tax at their individual rates.
But double taxation comes into play for traditional corporations, known as C corporations. This is because they’re not pass-through entities: The business pays income tax on its corporate net income, and then when profits or distributions are paid out to owners or shareholders, they’ll pay income tax at their individual rates
Do all states have corporate income tax?
No. In the US, state governments can set their own corporate taxes. Some states opt not to tax business income, earning status as tax havens. Others impose a flat corporate income tax rate, and some have tiered rates that increase as a business’s profits rise.
Note that laws can differ across state lines when defining a business’s nexus, or a connection to the state, meaning that the business has tax liability there. This can include operating physically in the state with a headquarters, warehouse, distribution center, or other offices, but details can vary.