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How Companies And Business Taxes Are Determined

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Any company registered under the US government needs to pay a certain part of their yearly earning to the government as “business tax.” The difference between their net revenue and the total operating expenses is known as their taxable income. Companies are required to pay taxes on this taxable income only. The business tax rate in the US has seen a decline over the last few decades. Yet, the US business tax rates are one of the highest in the world. So, how do American businesses plan for their taxes? How do the companies try to decrease their tax liability? How does the US business tax work in their capitalist economy?

In this piece, I will try to explore the different alleys of the US tax system and tell you how companies work in the current US taxation system.

Taxation in the USA – An Overview

According to statistics, US companies pay about 34% of their earnings as taxes to the Federal government. On top of that, the various US states have different tax slabs, which get levied on the companies. This tax amount is determined after careful consideration of various expenditures like G&A, COGS, SG&A, and Depreciation.

However, there is a standard formula for calculating the business tax –

Business Taxes = Taxable Income X Tax Rate

To find out the taxable income for your company, follow this formula –

Taxable Income = Adjusted Gross Earnings – All Applicable Deductions

The sum of all the earnings from the sold products, commissions, rents, interests, and other earnings is known as the Gross Earnings. To calculate the deductions, you need to sum up all the staff salaries, withdrawal fees, operating costs, and other miscellaneous charges.

Although the IRS allows taxpayers to consider any itemised deductions, they will still be charged under standard deductions if they don’t file it.

So, let’s check the fundamentals to understand how companies determine their business tax amount –

  • The businesses must determine any itemised deductions and their adjusted gross income to determine the taxable income.
  • Then the companies should multiply their taxable income by the applicable corporate tax rate to determine the absolute business tax amount.

Let’s explain this with an example –

The net profit for ABC company is 50,000 USD in the last fiscal year. The company can deduct up to 5,000 USD as its operating costs and miscellaneous expenses. A tax rate of 21% is levied on the company. Now it has to determine the tax bill.

To determine their tax amount, this is the step ABC company should follow –

  • Taxable income after deductions is 45,000 USD.
  • Incorporation tax = 45,000 USD x 21% – 9450 USD

So, ABC company needs to pay 9450 USD as business tax.

Here is another example to show you how business tax is calculated in the US –

Assuming your annual sales figure is 2,50,000 USD. Your qualifying expenses are valued at 55,000 USD. To calculate the tax liability, you need to deduct your annual revenues from the costs incurred. That will give you the net profit for the year.

First, you need to deduct 55,000 USD from the total sales figures, i.e., 2,50,000 USD. This makes the taxable income to be 1,95,000 USD.

Next, you have to multiply the taxable income by the tax rate of the federal government, 21% in this case. So, by multiplying 1,95,000 by 21% (0.21), we get 40,950 USD. So, the estimated tax value for the business will be 40,950 USD under federal taxes.

Taxation of businesses in the US is treated with utmost importance. Income tax in the US falls under the Tax Cuts and Jobs Act. In the US, the tax rates differ according to the state, with 35% being the highest.

In addition to the federal tax rates, the US states also levy their own corporate taxes. The tax rates on business earnings differ from one to nine percent. However, there are also some states that don’t charge any corporate tax.

Gross tax rates are most prevalent in states like Ohio, Nevada, Washington, and Texas. The state governments levy these taxes directly on the businesses instead of adding them with the traditional business taxes. Gross taxation is a bit more difficult than the traditional taxation rates since, here, the states levy the taxes before deducting the operating expenses.

Again, only business income is taxed by the Federal government if the business is based out of Wyoming and South Dakota. These two states don’t levy state-level business tax. At the same time, certain states impose business taxes on overall sales figures and business profits. In certain states, businesses pay a flat, uniform tax, while some states have the rule to pay different taxes as per the income level.

So, as we can see, barring a few states, most companies in the US pay taxes only after deducting the operational expenses. So, here is a list of the deductions as stated by the IRS –

  • Economic Losses
  • Taxation costs
  • Accounting costs
  • Marketing costs
  • Transportation costs
  • Legal costs
  • Wages
  • Bonuses
  • Employee benefits
  • Education reimbursements
  • Essential and regular business expenses
  • Insurance premiums
  • Bad debts
  • Interests paid
  • Gasoline taxes
  • Excise

The businesses can include all these expenses and sum the total of these overheads to deduct them from their net earnings. That way, their taxable income decreases, and companies will need to pay lesser taxes.

Recent Developments in Business Taxation

The TCJA, or Tax Cuts and Jobs Act, allowed full expensing of the new investments till 2023. This advantage is likely to get extended till 2026. Moreover, the TCJA placed a cap on the maximum a company can be taxed. According to recent developments, no company can be taxed more than 30% of AGI.

Additionally, TCJA also established a new tax structure called the BEAT. These new rules propose for a minimum domestic tax to stop the malpractice of businesses. Many companies used to transfer their profits to offshore companies to evade tax. Now with BEAT, the government hopes to encourage businesses to establish their intellectual property hubs within the United States. By doing so, the companies can get a part of their FDII deducted by the federal government.

Wrapping Up

All business entities ideally should file tax returns to their respective states and the federal government. Since they are subject to getting taxed from both ends, companies should try to itemise their stocks, expenditures, income, and any financial data within the fiscal years. By following the above-mentioned formulae, businesses can easily determine what tax amounts they need to pay. They will provide taxation law assignment help to evade unnecessary fines and other legal consequences for not following federal laws.

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