CORPORATE TAX STRUCTURE BASIC INFORMATION AND SAMPLE PROBLEM TUTORIALS

In order to make sound financial and investment decisions, a corporation’s financial manager must have a general understanding of the corporate tax structure, which includes the following:

1. Corporate tax rate schedule
2. Interest and dividend income
3. Interest and dividends paid by a corporation

4. Operating loss carryback and carry forward
5. Capital gains and losses
6. Alternative ‘‘pass-through’’ entities


Corporate Tax Rate Schedule
Corporations pay federal income tax on their taxable income, which is the corporation’s gross income reduced by the deductions’ permitted under the Internal Revenue Code of 1986. Federal income taxes are imposed at the following tax rates:

15% on the first $50,000
25% on the next $25,000
34% on the next $25,000
39% on the next $235,000
34% on the next $9,665,000
35% on the next $5,000,000
38% on the next $3,333,333
35% on the remaining income


Financial managers often refer to the federal tax rate imposed on the next dollar of income as the ‘‘marginal tax rate’’ of the taxpayer. Because of the fluctuations in the corporate tax rates, financial managers also talk in terms of the ‘‘average tax rate’’ of a corporation.

Average tax rates are computed as follows:
Average Tax Rate ¼ Tax Due=Taxable Income


Taxation Sample Problem and Solution

1. The average tax rate for the corporation in Example 1.5 is 35 percent (7,000,000/20,000,000). The marginal tax rate for the corporation in Example 1.5 is 35 percent.

As suggested, at taxable incomes beyond $18,333,333, corporations pay a tax of 35 percent on all of their taxable income. This fact demonstrates the reasoning behind the patch-quilt of corporate tax rates. The 15 percent–25 percent–34 percent tax brackets demonstrate the intent that there should be a graduated tax rate for small corporate taxpayers.

The effect of the 39 percent tax bracket is to wipe out the early low tax brackets. At $335,000 of corporate income, the cumulative income tax is $113,900, which results in an average tax rate of 34 percent ($113,900/$335,000). The income tax rate increases to 35 percent at taxable incomes of $10,000,000.

The purpose of the 38 percent tax bracket is to wipe out the effect of the 34 percent tax bracket and to raise the average tax rate to 35 percent. This is accomplished at taxable income of $18,333,333. The income tax on $18,333,333 of taxable income is $6,416,667, which results in an average tax rate of 35 percent ($6,416,667/$18,333,333). Thereafter, the tax rate is reduced back to 35 percent.