Taxation: Entities, Personal & Corporate Taxes

Taxation Overview

• U.S. taxation is complex due to the pursuit of loopholes, necessitating new regulations.
• Managers should be mindful that their decisions impact the organization's tax liability.
• Companies may face these taxes, in addition to federal income tax:
  • State and local income tax
  • Sales tax
  • Social Security tax
  • Real estate tax (property taxes)

Taxable Entities

• These entities are taxable:
  • Sole Proprietorship (84.62%)
  • Partnership (84.62%)
  • LLC or LLP (89.74%)
  • Corporation (89.74%)

Personal vs. Corporate Taxes

• Personal income tax applies to U.S. citizens and residents.
• Corporate income tax is levied on incorporated entities in the U.S.
• Sole proprietorship: owned and operated by one person
  • Business profits are the individual's profits
  • Reported on the individual's personal income tax form
• Partnerships: owned by more than one person
  • Partners report their share of business income on their personal tax returns

Corporations

• Corporations are subject to corporate income taxes.
• Distributing earnings to owners results in double taxation, as owners pay personal income taxes.
• Corporations can defer the second layer of taxes by retaining profits.
• Selling stock for profit results in a capital gain for the owners.
• Investments held over a year are taxed at lower rates than ordinary income.
• Impact of double taxation is deferred if a corporation doesn't pay dividends, partially offset by owners selling stock at lower capital gains rate.

Limited Liability Companies (LLCs)

• LLCs offer limited liability benefits to all owners.
• LLCs have the option to be taxed as corporations or partnerships.
• Some states may impose gross receipts taxes on LLCs.

Limited Liability Partnerships (LLPs)

• LLPs are partnerships, taxed accordingly
• Partners are responsible for their actions and those under their direction.

Tax Rate and Tax Base

• The tax base is defined as "Taxable income".
• Average tax rate is calculated by dividing total tax by taxable income.
• Marginal tax rate is the rate on the next $1 of income; it's a function of the highest tax bracket.
• 2017 MFJ tax brackets sample: 10% (up to $18,650), 15% (add'l up to $75,900), 25% (add'l up to $153,100).
• Effective tax rate is total tax divided by total income.
• Total income encompasses non-taxable amounts excluded from taxable income.

Tax Systems

• Alternative tax systems can be progressive, proportional, or regressive.
• A progressive system has increasing rates as the tax base increases.
• A proportional tax maintains one rate for all payers.
• A regressive tax has declining rates as the tax base grows.

Personal Tax Rates for 2024 (Married Filing Jointly)

• 10% : Up to $23,200
• 12% : $23,201 to $94,300
• 22% : $94,301 to $201,050
• 24% : $201,051 to $383,900
• 32% : $383,901 to $487,450
• 35% : $487,451 to $731,200
• 37% : $731,201 and up

Calculating Federal Income Tax

• Determine total income.
• Exclude specifically exempt items.
• High exclusions may be subject to the alternative minimum tax (AMT).
• Subtract deductions and exemptions from gross income (total income less exclusions):
  • Businesses: Basic expenses.
  • Individuals: Itemized or standard deductions and exemptions.
• The net result is taxable income.
• Apply tax rate schedules prior to tax credit consideration.
• Credits are subtracted after tax calculation; deductions are subtracted before.
• The remaining amount after subtracting credits is the tax obligation to the government.