8955 / How is a C corporation taxed?

Editor’s Note: The 2017 tax reform legislation permanently reduced the corporate tax rate from 35 percent to 21 percent.¹ The final version of tax reform did not provide a special tax rate for personal service corporations. The legislation also reduced the 80 percent dividends received deduction to 65 percent (for corporations that own at least 20 percent of the stock of another corporation) and reduced the otherwise applicable 70 percent dividends received deduction to 50 percent.² These provisions apply for tax years beginning after December 31, 2017.Unlike in the partnership context, a corporation is required to file a tax return and pay taxes at the entity level. The owners of the corporation (its shareholders) also pay taxes at the individual level based on any distributions received as dividend income based on stock ownership.

Prior to tax reform, a corporation paid tax according to a graduated rate schedule, which resulted in a lower tax rate for corporations with relatively modest earnings. The corporate tax rates ranged from 15 percent to 35 percent prior to 2018. The first $50,000 of a corporation’s earnings was taxed at the 15 percent rate, but the next $25,000 of earnings was taxed at 25 percent. Earnings above $75,000, but below $10,000,000, were subject to a 34 percent rate. A 35 percent rate applied to corporate earnings above the $10,000,000 level.³ Under the 2017 tax reform legislation, the maximum tax rate applicable to corporations is 21 percent rate.

Taxable income is computed for a corporation in much the same way as for an individual. Generally, a corporation may take the same deductions as an individual, except those of a personal nature (such as deductions for medical expenses and the personal exemptions (prior to their suspension from 2018-2025)). A corporation also does not receive a standard deduction.

Some deductions are allowed specifically for corporations, however, including a deduction equal to 50 percent (70 percent before 2018) of dividends received from other domestic corporations, 65 (80 percent before 2018) percent of dividends received from a 20 percent owned company, and 100 percent for dividends received from affiliated corporations (see Q 8956 for a detailed discussion of the deductions available with respect to dividends).⁴ A corporation may deduct contributions to charitable organizations to the extent of 10 percent (25 percent in 2020) of taxable income (with certain adjustments).⁵ Generally, charitable contributions in excess of the income limit may be carried over for five years.⁶

Prior to 2018, a corporation was also allowed a deduction for production activities. However, Section 199 was repealed for tax years beginning after 2017. This deduction was equal to nine percent of a taxpayer’s qualified production activities income (or, if less, the taxpayer’s taxable income). The deduction was further limited to 50 percent of the W-2 wages paid by the taxpayer for the year. The definition of “production activities” was broad and includes construction activities, energy production, and the creation of computer software.⁷

Capital gains and losses are netted for a corporation in the same manner as for an individual (see Q 8631) and net short-term capital gain, to the extent it exceeds net long-term capital loss, if any, is taxed at the corporation’s regular tax rates.

A corporation reporting a net capital gain (where net long-term capital gain exceeds net short-term capital loss) is taxed under one of the two following methods, depending on which produces the lower tax:

1. Regular method. Net capital gain is included in gross income and taxed at the corporation’s regular tax rates.


2. Alternative method. First, a tax on the corporation’s taxable income, exclusive of net capital gain, is calculated at the corporation’s regular tax rates. Then a second tax on the net capital gain (or, if less, taxable income) for the year is calculated at the rate of 21 (or 35 percent prior to 2018) percent. The tax on income exclusive of net capital gain and the tax on net capital gain are added to arrive at the corporation’s total tax. Prior to 2018, for certain gains from timber, the maximum rate was 23.8 percent (15 percent before 2016).⁸