Special Corporate Tax Deductions That You Need to Know

corporate tax deductions

Tax season is usually the least exciting time of the year for business owners, and filing corporate tax can bring headaches. But in most cases, business owners aren’t aware of all the special corporate tax deductions available only to them. 

Check this article to find out if you’re missing potential savings by not taking advantage of all these deductions! 

Dividends received deduction 

The dividends received deduction (DRD) is a federal tax deduction in the US that applies to certain corporations that get dividends from related entities. 

Similar to individuals, corporations must pay tax on the dividends they receive from other corporations, but usually at a higher tax rate. Without a special corporate tax deductions rule, the tax rate on dividends received is often damaging to corporations because they are taxed at three or more taxation levels.

In particular, a corporation pays the first taxation level on its income before distributing its after-tax income to its shareholders. The second taxation level incurs when the shareholders pay their taxes on their dividends. The third taxation level is when the corporation distributes the after-tax income from the dividends to its shareholders. There are even more levels of tax depending on the business’s structure. 

Generally, a US corporation may deduct 50% to 100% of dividends received in calculating taxable income. Different tiers of possible deductions depend on how much ownership the company has in the dividend-paying company. 

Particularly, the deduction rate for tax years beginning after 2017 is 50% of dividends received when the ownership percentage is less than 20%. This rate increases to 65% when the ownership percentage is at least 20% but less than 80%. The DRD rate is 100% deductible when the ownership is 80% or more.

However, there are several rules that corporate shareholders must follow to qualify for a DRD, including: 

  • Corporations cannot deduct bonuses from a real estate investment trust (REIT) or capital gains from a managed investment company.
  • Dividends received from domestic companies have different deduction rules than dividends received from foreign corporations.
  • The DRD is only legalized if the corporation has held the stock for more than 45 days.

Organizational cost deduction

Another special deduction available only to corporations is organizational costs. Organizational costs are expenses for organizing a corporation or partnership, including but not limited to: 

  • Legal services
  • Accounting services
  • State fees for incorporation or filing fees for partnerships
  • Expenses for temporary directors and organizational meetings for corporations

Organizational expenses do not include those incurred to issue or sell stock shares or transfer assets to a corporation. Organizational expenses are also different from start-up expenses. Start-up expenses include business investigation costs (e.g., market surveys) and operating expenses, which are incurred before a business officially launches. 

If your business type is a corporation, you can deduct up to $5,000 of your organizational costs and amortize the remaining over 180 months. The $5,000 deducted for organizational costs must be reduced by the amount by which the costs exceed $50,000.

Only expenses incurred prior to the end of the tax year in which the corporation started its business are eligible for deductions. However, a corporation still can claim this deduction by capitalizing all organizational costs and deducting them when the company is liquidated or terminated.

The bottom line

Understanding your qualifying corporate tax deductions helps you lower your tax liabilities, save and invest money in other potential areas. If you’d like to explore more helpful tax knowledge and tax-prep tips, we encourage you to subscribe to the Shoeboxed blog

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