Federal and state tax law have recently undergone a change particularly since 2017. Many states have reduced corporate tax rates in the last ten years but what about capital gains tax for corporations?
We look at what capital gains tax is, what corporation tax is and the difference between the two. We will then look at the issue of whether corporations actually pay capital gains tax.
What Is Capital Gains Tax?
Capital gains tax is a charge or levy on the profit made from investment when the investment is sold. When investment assets that are subject to tax such as stocks or shares are sold the resulting profit or ‘capital gains’ is said to have been realized.
As such it does not apply to investments or assets that are ‘unrealized’ or unsold. So for example stocks and shares are not liable to capital gains tax regardless of whether they have increased in value since they were purchased.
Only if they are sold for a profit will they be subject to capital gains tax. This applies to any asset that is owned or used for personal or investment purposes. A house is an example of a capital asset that is held by an individual.
If the property is sold at a higher price than its adjusted basis it is said to have made a capital gain. The adjusted basis is typically the cost of the asset to the owner. If the asset is sold for less than the adjusted basis it is said to be a capital loss.
Capital gains, and losses, are classified as either long term or short term. If you hold on to an asset for more than a year before selling it your capital gain or loss is deemed to be long term. If the asset is held for less than a year the loss or gain is said to be short term.
What Is Corporation Tax?
Corporation tax is the tax on a company’s profits. They are paid on a corporation’s income including revenue less the cost of goods sold, administrative and general expenses, R&D, marketing and depreciation among other costs.
However corporate taxes can be reduced through deductions, tax loopholes and government subsidies. So the rate that corporations pay is typically lower than the flat rate.
Expenses which are currently necessary for the corporation’s operations are fully deductible. Employee salaries, health benefits and insurance premiums are tax deductible.
Any real estate or investments which are bought for the purpose of generating income are also deductible.
The amount of deductions available means that paying corporation tax is more beneficial for business owners than paying individual income taxes.
Corporations can also deduct losses while a sole proprietor would need to provide evidence of the intention to make a profit before any losses are deducted. Corporation profits can also be left within the company allowing for potential future tax advantages and planning.
Corporation tax is a source of income for the government. The flat rate of corporation tax in the United States is currently 21% down from a maximum rate of 35% prior to 2017.
Difference Between Capital Gains Tax & Corporation Tax
Capital gains tax is most commonly realized on the sale of assets such as stocks, bonds, real estate or property. Corporation tax is the levy on a company’s profits.
Capital gains tax is payable in the year in which the gain is realized, corporation tax is payable on or before the 15th April of the following year in the case of a calendar year corporation.
For a fiscal year corporation the tax is due on the 15th day of the fourth month after the close of the tax year.
Corporation tax payable by a company can be lowered through the use of government subsidies, tax loopholes or deductions and so may not be payable at the current rate.
Capital gains tax has no such methods of reduction and the rate is 21%. However there is a distinction between long and short term capital gains.
Do Corporations Pay Capital Gains Tax?
Capital gain is considered the excess of net long term capital gains over net short term capital loss.
For corporations capital losses excesses over capital gains in a single tax year can be carried back over three years or forward five years in order to be offset against the capital gains.
Disposing of certain non-residential real estate or personal property used in a business that results in a net gain would mean that this gain is taxed first as ordinary income to the extent of depreciation to cost recovery. Anything remaining would be considered capital gain.
In relation to other business real property net gains are typically taxed as ordinary income where the cost recovery claimed is in excess of the straight line amount and any remainder would be treated as capital gain.
An exception to the treatment of capital gain would be where losses on a business’ assets were recognized in previous years. The sale of business assets that results in a loss is treated as an ordinary loss.
However future gains will be treated as ordinary income concerning re-characterized losses recognized in the previous five years.
Corporate shareholders do not pay tax on corporate income but instead receive dividends which are then treated as capital gains. As a corporation already pays tax on its profits which are then distributed to shareholders this raises the problem of double taxation.
Some corporations attempt to avoid distributing earnings as dividends to avoid such an issue, but they must justify this action to the IRS as a valid reason such as a move to expand the business.
Capital gains tax paid by individuals is quite straightforward being the profit on the sale of an asset held for more than one year.
Corporate capital gains tax is much more akin to an income tax while shareholders of corporations pay capital gains on the dividends paid out of the company’s profits.