Corporate vs Personal Income Tax

What is Corporate vs. Personal Income Tax?

Corporate tax is a direct tax paid by businesses on their earnings and capital to the government. When companies fill in the income statements, they deduct tax from earnings to get net profit.

It is applied to the following organizations:

1. Businesses established in the country
2. Foreign companies operating inside the country
3. For businesses that are residents for tax purposes inside the country

The Corporate Tax imposed before the year 2017 was about 35%. After the Tax Cuts and Jobs Act, US resident corporations have to pay a tax of 21%. It is imposed on the taxable profits of the corporation. Taxable profits are the firm's total revenue less allowable deductions. 

These deductions are the cost of goods sold (COGS), wages, other employee costs, interests, amortization, and depreciation.

The other changes under the Tax Cuts and Jobs Act comprise the elimination of the graduated corporate rate schedule and corporate alternative minimum tax. However, some states have alternative taxes.

It also limits the interest expense to 30% of adjusted taxable income.

What is Alternative Minimum Tax?

Many big companies utilize the tax deductions optimally to become zero or marginal tax companies. To overcome this issue, the government introduced the Alternative Minimum Tax.

Personal income tax is direct tax paid by individuals on their income - salaries, capital gains, etc.

Recently, along with tax reduction, there has been a reduction in the number of tax brackets. Here are a few tables mentioning the tax brackets for different categories of taxpayers:

1. Single Taxpayer

2. Married Taxpayers filing jointly

3. Head-of-household Taxpayer

4. Married taxpayers filing separately

The source for the above 4 Tax slab tables can be found here.

What Are Corporate Tax Savings?

The following are the savings:

1. Qualified Business Income Deduction

When the Tax Cuts and Jobs Act (TCJA) came into effect in 2018, it created the Qualified Business Income (QBI) deduction.

Suppose a company is a sole proprietorship, a corporation, or a partnership that passes income and deductions down to its shareholders, partners, or owners to report on their returns. In that case, one could be eligible to deduct 20% from their qualifying business income.

You may deduct this charge in addition to your regular company expenses. If your taxable income is less than $157,500 or $315,000 if you're married and filing a combined return, you should be eligible.

Depending on the type of business, you can still be eligible if you make more than these sums (Special criteria apply).

2. Fund a Retirement plan

You can save money on taxes by creating and supporting a retirement plan for you and/or your workers. To benefit from the tax advantages, make sure it is a qualifying plan. 

It must be an IRS-recognized method to allow deferring taxes on earnings until the earnings are withdrawn. They consist of defined contribution plans like a 401(k) or 403(b), as well as IRAs.

3. Applying for tax credits for lowering business income

The federal government uses tax credits to motivate organizations and individuals to take actions—or not take actions—that advance society.

For instance, you can claim tax credits for employing staff, adopting environmentally friendly practices, granting disabled staff and members of the public access, and offering health insurance to employees.

The majority are a part of the General Business Credit, a broad category, so it's feasible that you meet some of its requirements. Please consult your accountant.

4. Depreciation Deductions on Equipment and Vehicles

Businesses can deduct the cost of buying office supplies, machinery, automobiles, and occasionally even real estate from their taxes. Sometimes you can take these write-offs in the first year because you own and use the equipment.

Section 179 deductions and bonus depreciation are the two most typical instances of this accelerated depreciation.

When you put certain assets into operation, you can immediately deduct the costs of those assets under Section 179 deductions. The Tax Cuts and Jobs Act increased the maximum deduction to $1 million in 2018. (TCJA).

Purchases of specific real estate, machinery, and equipment may qualify.

5. Writing off Bad Debt

If your company uses accrual accounting, the end of the year is also an excellent time to evaluate your client accounts. Find the clients who are least likely to pay you first.

To avoid paying taxes, you can write off the money they owe as "bad debts" and exclude it from your revenue from operations.

6. Other Expenses

The other expenses that can be written off include Charitable contributions, Foreign-derived intangible income (FDII), Research and experimental expenditures, and the cost of goodwill acquired in an asset acquisition.

Corporate Vs. Personal Tax

Personal Tax Deductions

The taxable income is different from the actual income of the individual. Many components aid in tax deductions, tax exemptions, etc. Let us look at a few of the ways that can help in reducing taxable income. For simplicity, we divide them further into plans and current expenses.

Plans

1. W-4

A W-4 form is an Internal Revenue Service (IRS) form. It is also known as an "Employee's Withholding Certificate." It instructs employers how much tax should be deducted from each employee's paycheck.

Employers use the W-4 form to calculate payroll taxes and remit them on behalf of employees to the IRS and the state (if applicable)

2. 401-k

A 401(k) plan is an employer-sponsored retirement program that accepts payments from eligible employees. The employee's salary or wage is reserved to cover the required payments.

IRS does not tax the income directly transferred to the 401k account. Each 401k account has an upper limit of $20,500.

3. Contribution to Individual Retirement Accounts

By contributing to the IRA, one can have a deduction in tax by the same amount. However, there is a limit that is adjusted yearly based on inflation.

There are two types of IRA - Traditional IRA and Roth IRA. The contribution to a Roth IRA takes place after the tax is paid. Hence, a Traditional IRA is one that helps with Tax deductions.

Though a Roth IRA has no current-year tax benefits, the contributions grow tax-free. In addition, the withdrawals from both the IRAs are tax-free.

4. College savings

This is a 529 plan which encourages savings for future education. Withdrawals from 529 plans for higher education are, in many cases, exempt from federal and state taxes.

These education saving plans have underlying Mutual Funds or ETFs. Hence these are tax-free growth investments.

There are two sub-plans under the 529 plan:

a) Prepaid tuition plans

A beneficiary of a prepaid tuition plan can acquire units or credits at participating colleges and universities (often public and instate) for future tuition and required fees at the current price.

Prepaid tuition plans do not allow to prepay for tuition at elementary and secondary schools, nor can they be used to cover future room and board at colleges and universities.

The Federal government does not guarantee the sponsorship of this plan; however, the state governments do participate.

b) Education savings plan

A saver can open an investment account through an education savings plan to put money aside for the beneficiary's future higher education costs, including tuition, obligatory fees, and room and board.

In principle, withdrawals from education savings plan accounts may be utilized at any college or university, including occasional institutions outside the United States.

Additionally, beneficiaries of education savings plans may utilize them to pay up to $10,000 in annual tuition at an elementary or secondary school, whether public, private, or religious, per beneficiary.

5. FSA funding

A flexible spending account (FSA), also referred to as a flexible spending arrangement, is one of several tax-advantaged bank accounts that can save payroll taxes in the United States.

The medical expense FSA, also known as a medical FSA or health FSA, is the most popular type of flexible spending account. It is comparable to a health savings account (HSA) or a health reimbursement account (HRA).

Medical FSAs are frequently given with more conventional health plans, but HSAs and HRAs are virtually exclusively used as parts of consumer-driven health care plans.

Additionally, unlike savings in an FSA, funds in an HSA are not lost at the plan year's end. The major advantage of FSA is contributions and withdrawals are tax-free.

Expenses

The following are the expenses:

1. HSA

One cannot itemize medical deductions for the same costs if this is to utilize a health savings account (HSA) to pay for medical expenses.

However, one might be able to deduct them as an itemized deduction if they had sufficient medical expenses that the HSA didn't cover.

Deductible expenses must exceed 7.5 percent of the adjusted gross income to itemize (AGI). The AGI of the concerned person is reduced by an HSA contribution deduction, which can make it simpler for them to overcome the 7.5 percent barrier.

2. Earned income tax credit

The Earned Income Tax Credit (EITC) is a labor credit that could lessen the federal tax liability or give the taxpayer money back at the tax time. The primary prerequisite is that they must have a job that pays money.

Any federal taxes a taxpayer owes at tax time may be canceled out by the credit. They receive the difference in their tax refund if the amount of the EITC is greater than what they owe in taxes.

Even if they don't owe income tax, they may still be eligible for a refund, provided all the requirements are met.

3. Donations

Americans have a financial incentive to contribute freely to charity since they can deduct their charitable contributions from their income taxes when they donate to a 501(c)(3) public charity.

The taxpayer can use charity tax deductions to lower their taxable income and tax obligation.

If they intend to claim their charitable deduction after deciding to donate to charity, take into account the following steps:

1. A 501(c)(3) public charity or private foundation should be the non-profit organization's status.
2. Maintain a donation record (usually the charity's tax receipt).
3. In some cases, they may need to obtain a qualified appraisal for a non-cash donation to support the amount of the deduction they're claiming.
4. They should prepare their documentation, itemize their deductions, and submit their tax return.

4. Medical expenses

Taxpayers may be entitled to deduct costs they paid for medical and dental care for themselves, their spouse, and their dependents if it is planned to itemize their deductions for a tax year on Schedule A (Form 1040) Itemized Deductions.

Only part of their overall medical expenses that exceed 7.5 percent of their adjusted gross income is allowable as a deduction. It is to be determined by the concerned person the deduction amount on Schedule A. (Form 1040).

5. Deductions on stock losses

Stock market losses can be filed on Form 8949 and Schedule D of the Tax return. The upper limit on stock loss deduction is $3,000.

Researched and authored by Punit Manjani | LinkedIn

Reviewed and edited by Parul Gupta | LinkedIn

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