Incorporated Business Taxes Explained

As a business owner, it's essential to understand the tax implications of incorporating your business. For example, a C corporation is taxed on its profits, and then its shareholders are taxed again on the dividends they receive.

The tax implications of incorporation can be complex, but it's worth noting that C corporations can deduct the salaries they pay to their employees, which can help reduce their tax liability.

Incorporation can also provide liability protection for business owners, but this doesn't necessarily mean they won't have to pay taxes. As we'll explore later, the tax benefits of incorporation can be significant, but they're not without their limitations.

Business owners should carefully consider their tax obligations when deciding whether to incorporate their business.

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A corporation is a separate entity from its owners, known as shareholders, and is taxed on its profits. This is in contrast to a sole proprietorship or partnership, where the business and owner are one and the same.

A corporation can have multiple classes of stock, which can be beneficial for attracting investors. For example, a company may issue common stock to the general public and preferred stock to institutional investors.

The tax implications of a corporation's business structure can be complex, but it's essential to understand the basics to make informed decisions.

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As a shareholder, you're not just an owner of a business, but also a taxpayer. Corporate profits can be subject to a second layer of taxation at the individual shareholder level, both on dividends and on capital gains from the sale of shares.

Dividends are taxed differently depending on whether they're qualifying or non-qualifying. Qualifying dividends, which make up most ordinary dividends of U.S. corporations, are taxed at a maximum rate of 23.8 percent.

If you receive non-qualifying dividends or short-term capital gains, you'll be taxed as ordinary income, with a maximum rate of up to 40.8 percent. This is the top marginal individual income tax rate of 37 percent plus the 3.8 percent tax on net investment income.

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As a shareholder, you may not be subject to the corporate income tax, especially if the business is set up as a pass-through entity. Pass-through businesses include sole proprietorships, partnerships, limited liability companies (LLCs), and S-corporations, which do not face an entity-level tax.

Instead, the owners of pass-through businesses must include their allocated share of the business's profits in their taxable income under the individual income tax.

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A C corporation is a type of business entity that is taxed as a corporation for federal income tax purposes.

In Colorado, a C corporation is considered doing business in the state if it exceeds the minimum standards of Public Law 86-272 and has a substantial nexus with the State of Colorado.

A C corporation is defined as any organization taxed as a corporation for federal income tax purposes, including corporations, joint stock companies, real estate trusts, financial corporations, and limited liability companies taxed as corporations.

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To be considered a C corporation, a business entity must file IRS Form 2553 to elect S corporation status, or make an election to be classified as a C corporation by filing IRS Form 8332.

Domestic C corporations are subject to Colorado income tax, and must file a Colorado C Corporation Income Tax Return (DR 0112).

A domestic holding company is any C corporation formed under the laws of any state or the United States that has less than $100,000 of property and payroll, combined.

C corporations may be required to file a combined return if they are part of an affiliated group and meet certain conditions, including having less than 80% of their property and payroll assigned to locations outside the United States.

Here is a list of the types of C corporations that may be subject to Colorado corporate income tax:

Colorado conforms to federal law for tax purposes, but there are certain federal deductions that are not allowed for Colorado purposes. C corporations must add back these deductions when calculating their Colorado tax.

To determine which deductions are not allowed, you can refer to the list of statutes and regulations provided by the Colorado Department of Revenue. This list includes relevant sections of the Colorado Revised Statutes (C.R.S.) and federal regulations.

Here are some key statutes and regulations to keep in mind:

You can exclude certain types of income from U.S. government obligations from Colorado taxation. This includes interest income on obligations of the United States and its possessions.

Interest or dividend income on obligations or securities of any authority, commission, or instrumentality of the United States is also exempt from Colorado taxation. However, income from instruments issued by private financial institutions and guaranteed by the U.S. government is not eligible for this exemption.

To qualify for this subtraction, the income must be included in your federal taxable income. No subtraction is allowed for any obligation or payment from the U.S. government for services rendered.

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In New Mexico, every domestic and foreign corporation is required to pay a Corporate Franchise Tax, regardless of whether they're actively engaged in business or not.

This tax is triggered by exercising the corporate franchise, which means seeking treatment as a legal entity under state law.

Some common indicators of exercising a corporate franchise include registering with the Public Regulation Commission or any regulatory agency of the state.

You'll also be considered to have exercised your corporate franchise if you appoint a registered agent in New Mexico to accept service of legal process on behalf of your corporation.

Additionally, exercising your corporate franchise can be as simple as appointing an agent to carry on activity within the state or using the New Mexico judicial system to enforce contractual provisions or collect debt.

Here are some specific actions that indicate exercising a corporate franchise in New Mexico:

In Colorado, tax laws are governed by specific statutes and regulations. The Colorado Revised Statutes (C.R.S.) provide the framework for taxation, including definitions, exemptions, and corporate tax.

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§ 39-22-103, C.R.S. defines key terms used in taxation, ensuring clarity and consistency. This definition is crucial for understanding the tax laws and regulations.

The C.R.S. also outlines which persons and organizations are exempt from tax under Article 22. § 39-22-112, C.R.S. provides a list of exempt entities, which can be found in the statute.

Corporate tax is imposed under § 39-22-301, C.R.S., which sets the rate and requirements for corporate taxation. This tax applies to S corporations, as outlined in § 39-22-302, C.R.S.

Taxation of S corporations and their shareholders is governed by § 39-22-322, C.R.S. This statute clarifies how S corporation profits are taxed, ensuring fairness and consistency.

The Colorado Revised Statutes are complemented by federal regulations, including 15 U.S.C. § 381, which imposes a net income tax. This federal regulation is important for understanding the broader context of taxation.

For businesses operating in Colorado, it's essential to understand the federal classification of business entities. 26 CFR § 301.7701-2 provides definitions for various business structures, while 26 CFR § 301.7701-3 outlines the classification of certain business entities.

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A combined return is a way for C corporations to file their taxes together, and it's a bit more complex than a regular return. To qualify, a C corporation must be part of an affiliated group, which means it's connected to other C corporations through stock ownership.

There are certain conditions that must be met for a C corporation to be included in a combined return. It must be part of an affiliated group, less than 80% of its property and payroll must be outside the United States, and it must satisfy at least three of the six tests of unity.

The six tests of unity are:

The net income of the affiliated C corporations included in a combined return is determined by the rules and regulations promulgated pursuant to section 1502 of the Internal Revenue Code and modified by the additions and subtractions required or permitted by Colorado law.

Foreign source income includes types of income enumerated in IRC section 862(a), such as dividends, interest, and rent from real property.

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Income allocated to sources without the United States pursuant to IRC section 863 is also considered foreign source income.

Subpart F income, Global intangible low-taxed income (GILTI), and Gross-up under IRC section 78 for foreign taxes deemed paid are all types of foreign source income.

Any item of income treated as arising from sources outside of the United States under treaty obligation of the United States as described in IRC section 245(a)(10), 904(d)(6), or 904(h)(10) is also considered foreign source income.

Deductions apportioned and allocated to gross income from sources without the United States include the deduction allowed pursuant to section 250 of the Internal Revenue Code.

Foreign source income is determined without regard to section 882(a)(2) of the Internal Revenue Code for a foreign C corporation within an affiliated group of C corporations.

Foreign source income includes income from sources without the United States, determined in accordance with section 862 of the Internal Revenue Code.

The following types of income are considered foreign source income:

A REMIC, or real estate mortgage investment conduit, is subject to a specific limitation under section 860E of the Internal Revenue Code. This limitation prohibits the offset of a Colorado net operating loss by an excess inclusion in a REMIC.

To determine the portion of a C corporation's Colorado taxable income that may be offset by a Colorado net operating loss, you must first reduce the corporation's federal taxable income by any excess inclusion determined pursuant to section 860E.

Colorado C corporations must file a Colorado C Corporation Income Tax Return (DR 0112) and complete an Apportionment Schedule (Schedule RF) to report their income and calculate their net operating loss.

The net operating loss deduction is governed by 26 U.S.C. § 172, and the definitions of consolidated taxable income are found in 26 CFR § 1.1502-1.

Here are the relevant Colorado and federal regulations that govern net operating losses for C corporations: