Corporate Taxation and the Value of Cash Holdings

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A corporate accountant prepares a tax report.

Accounting is the oldest and perhaps most important form of business intelligence. Without a clear and accurate record of money spent and money earned, a business has no idea whether it’s thriving or failing, and no way to plan for the future. Accounting is the key to planning for and minimizing a business’s tax burdens, although accounting and taxation are distinct operations.

Accounting is the collection, analysis, verification, classification, interpretation, and presentation of financial information.
Taxation is the financial obligation imposed by governments or other taxing authorities on individuals and businesses.

A corporation’s income tax obligation is based on its taxable income after deductions and tax credits are applied. (Note that companies have tax obligations other than those that apply to their income, such as sales taxes and payroll taxes.) One of the biggest challenges facing corporate tax accountants is responding to the constant changes to corporate tax laws. In particular, corporate taxation can affect the value of the firm’s cash holdings, or cash reserves, which include all cash on hand as well as short-term investments.

Corporate tax accountants are experts at knowing which deductions and other tax advantages are available to a company. They help organizations prepare for future changes in the tax code and maximize all of the tax credits for which they qualify. The role of corporate tax accountants becomes more vital to a company’s financial health during times of economic, political, and social uncertainty.

What Is Corporate Taxation?

Corporate income tax is the amount that a government levies against a corporation’s profits. Behind this simplified definition is a raft of regulations and policies that set the corporate tax burden based on many different and competing economic policies. For example, some countries or states or counties attempt to attract businesses by offering low tax rates in exchange for the revenue generated by creating jobs and occupying facilities. In extreme situations, these locations are considered corporate tax havens.

A company’s tax liability varies based on the type of business entity it is.

C corporations are taxed by the federal government separately from their owners, which is referred to as double taxation since owners may be taxed twice on the same income.
S corporations and partnerships pass income, losses, credits, and deductions to shareholders. They are sometimes called pass-through or flow-through entities.
Limited liability companies, or LLCs, also pass through income to owners, who are referred to as LLC members. An LLC is by default either taxed as a flow-through entity, like a partnership or a sole proprietorship (if there is only one owner and the owner is an individual person), or like a disregarded entity (if there is only one owner and the owner is a corporation). LLCs can elect to be taxed like a corporation (“check-the-box rules”).
Nonprofit corporations usually qualify for exemptions on income tax and other federal and state taxes, but they must apply to the Internal Revenue Service for federal income tax exemption. They also have to file information returns, which (depending on the size of the organization) can be quite complex. Noncompliance can be costly because the organization can lose its tax-exempt status.

How a Corporation’s Taxable Income Is Calculated

A corporation’s taxable income is calculated by subtracting from its total revenue the cost of goods sold (COGS), general and administrative (G&A) expenses, selling and marketing expenses, research and development expenses, depreciation, and other operating expenses. The current U.S. corporate income tax rate of 21% has been in place since 2018; prior to that, it was 35%. Certain tax credits may reduce a corporation’s tax liability.

In the 2019 fiscal year, corporate taxes totaled $230.2 billion for the federal government, which represents 6.6% of total federal revenue, compared to 9% in 2017, according to the Tax Policy Center. By comparison, individual income taxes amounted to $1.6 trillion in revenue for the federal government in 2019, or about 25% of total federal revenue, and payroll taxes (used to fund social programs such as Medicare and Social Security), generated about $1.24 trillion in federal revenue, which is about 20% of the total.

Corporate Tax Rates Vary by Country

Of the 20 countries that changed their tax rates in 2021, three increased their rate (Argentina, Bangladesh and Gibraltar) and 17 reduced it, including Chile, France and Tunisia, according to the Tax Foundation.

The average statutory corporate income tax rate across 180 worldwide jurisdictions is 23.54%, which increases to 25.44% when weighted by gross domestic product (GDP).
The countries and territories with the highest corporate tax rates are Comoros (50%), Puerto Rico (37.5%) and Suriname (36%), while those with the lowest rates are Barbados (5.5%), Uzbekistan (7.5%) and Turkmenistan (8%).
As of 2021, 15 countries impose no income tax on corporations. Most of these countries are small island nations such as the Cayman Islands and Bermuda, both of which are noted tax havens, although the United Arab Emirates also imposes no corporate income tax.

Techniques Accountants Use to Lower Corporate Tax Liability

While large, publicly traded firms are required by the IRS to use the accrual accounting method, corporate accountants who work for smaller private companies generally can choose between using cash basis or accrual accounting when calculating a business’s income tax liability.

Cash basis reports revenue on the income statement only when the payment is received, and expenses are recorded only when they are paid out. This method is popular with small businesses.
Accrual records revenue when it is earned, such as on delivery of a product or service. This may occur before or after payment is received.

The tax advantages of cash accounting include the ability to time transactions in a manner that they allow for lower taxes. However, this method doesn’t provide a clear picture of the business’s financial state and can cause misleading or inaccurate financial reporting. Accrual accounting is mandated by the generally accepted accounting principles (GAAP) and is required for raising or borrowing funds from banks or investors. It makes financial planning more accurate and provides a clearer picture of the company’s financial status.

Just like individual taxpayers, corporations can employ tax deductions or tax credits to reduce their overall tax liability. Tax deductions reduce taxable income while tax credits reduce the tax liability dollar for dollar. Companies may also qualify for government subsidies. These are not part of tax reporting but rather paid directly to the company via different means.

Tax Deductions

The primary source of tax deductions for corporations is business expenses, which are any reasonable expenses deemed “ordinary and necessary” to conduct operations. In addition to the amount of state income taxes paid and the cost of goods sold, capital expenses such as startup costs and business asset purchases and improvements can be deducted, as long as they’re in very small amounts. Otherwise, these costs must be capitalized and then amortized or depreciated. Generally, the amount spent can be deducted for each expense. However, if the company subsequently recovers any part of the deducted expense, either in the same tax year or a later year, the amount recovered must be subtracted from the deduction that was claimed on their previous tax return.

Government Subsidies

The three industries that receive the most government subsidies are agriculture, energy, and transportation. The payments take the form of tax accounting allowances, credits, exemptions, deductions and depreciation. Government subsidies help businesses in three ways:

By paying part of the cost of producing a product or service
By offering tax credits or reimbursements, such as those available to purchasers of electric cars and other environmentally friendly products
By paying part of the cost that a consumer would normally pay for a product or service

Tax Planning Opportunities

Corporations can reduce the amount of federal income tax they owe by shifting profits to subsidiaries located in other countries that have lower corporate income tax rates, including tax havens such as Bermuda and the Cayman Islands. Note that this practice has been significantly limited with the Tax Cuts and Jobs Act (TCJA) of 2017, as part of the rationale for the tax law change was to ensure foreign earnings are being repatriated and taxed in the United States.

In addition to jurisdiction, the other key variables involved in tax planning include time (moving income and expenses from one year to another when possible), entity (selecting the optimal classification for a business) and character of income. For this last variable, the options for corporations are fairly limited, but individuals have much more flexibility.

Some common forms of corporate tax planning include:

Paying owner-employees salaries instead of dividends (to the extent that it’s reasonable)
In states where it’s permitted, changing the apportionment formula of income to reduce income taxed in a state with a higher tax rate
Optimally using carrybacks and carryforwards of losses (especially when the rules change, as is often the case during economic downturns)
Changing the entity from flow-through to taxable, or the other way around, depending on the company’s profits and the owners’ individual tax situation

How Corporate Taxation Differs from Taxation of Other Types of Businesses

The rules for corporate taxation are much different from those that apply to other business entities such as sole proprietorships, partnerships, S corporations and LLCs. The IRS explains the tax rules for five types of businesses:

Sole proprietorships are one-person operations that haven’t been incorporated. In addition to paying a tax on their income, sole proprietors are liable for self-employment tax, and federal unemployment taxes.
Partnerships are two or more people operating a trade or business to which each contributes money, resources, skills or labor. Partnerships may have to pay taxes other than income taxes such as payroll, property, sales, and excise taxes, while the partners will be responsible for income tax and self-employment tax.
Corporations are incorporated business organizations. They are legal entities authorized by the state to conduct business. For tax purposes there are two types: A C corporation is a taxable entity. An S corporation is a business that chooses to be taxed under Subchapter S of the Internal Revenue code. Both types of corporations may be required to pay income and other taxes. This is true even though S corporations are flow-through entities. The IRS notes that S corporations are liable for tax on some built-in gains and passive income at the entity level.
LLCs are business entities whose owners are called members and may include individuals, corporations, other LLCs or foreign parties. Based on the number of members and the classifications that members have elected to make (corporation or partnership, for example), they may choose to have the LLC taxed as a corporation, partnership or part of the LLC owner’s personal income tax return. In the last case, the LLC is “disregarded as separate from its owner.”

What Is the Effective Tax Rate?

Effective tax rate is the percentage of the income earned by a person or corporation that they pay in taxes. For a corporation, its effective tax rate is the average tax rate applied to its pretax profits. It doesn’t include state and local taxes (on items other than income), sales taxes, property taxes or other taxes a corporation may be obliged to pay. A corporation’s effective tax rate may differ from the statutory 21% tax rate due to permanent book-tax differences such as permanently reinvested foreign earnings and various tax credits.

Corporate Taxation and Corporate Accounting

Accountants play key roles in minimizing their corporate clients’ tax burdens by identifying all of the corporate tax credits and deductions for which they qualify. Corporate tax accountants are responsible for ensuring their companies are prepared to meet their tax obligations and have minimized their tax bill as part of their long-term strategy.

The results of accounting firm KPMG’s third annual survey of chief tax officers (CTO) indicate the top concerns of corporate tax officials. According to the CTOs, the greatest threats to organizations through 2024 are regulatory risk as a result of changes to the tax code (cited by 72% of respondents), talent risk of finding tax professionals with the requisite skills (52%) and operational risk in applying machine learning and other artificial intelligence and data analytics technologies (38%).

Corporate Income Taxes Imposed by States

In addition to a federal tax on corporate income, 44 states impose a corporate income tax. The levies imposed by states on corporate income range from 2.5% in North Carolina to 11.5% in New Jersey, according to The Tax Foundation. In fiscal year 2020, corporate income taxes represented 4.93% of total state tax collections and 2.26% of state general revenue.

In place of an income tax, Nevada, Ohio, Texas, and Washington impose a tax on gross receipts, while Delaware, Oregon and Tennessee have both gross receipt taxes and corporate income taxes. Pennsylvania, Virginia, and West Virginia have corporate income taxes and allow gross receipt taxes to be imposed at the local level but not by the state. South Dakota and Wyoming have neither a corporate income tax nor a tax on gross receipts. North Dakota is phasing out its corporate income tax and expects to have no tax on corporate income or gross receipts by 2030. State income taxes are generally deductible for federal tax purposes.

How Changing Tax Policies Challenge Corporate Accountants

Tax policies are constantly changing, sometimes as a result of changes in government administration. In 2021, the Biden administration’s Build Back Better Act stalled in the U.S. Senate after passing in the House of Representatives. That bill would impose a 15% minimum tax on large corporations as well as a 15% global minimum tax. It also includes a surcharge on corporate stock buybacks and would make the Medicare net investment income tax apply to more people.

Changes in international corporate tax rules and U.S. tax policies related to the overseas operations of U.S. firms also complicate the process of planning and calculating a company’s tax liability. In December 2021, the Organisation for Economic Co-operation and Development (OECD) released the Pillar Two Model Rules that will impose a 15% minimum tax rate on multinational enterprises beginning in 2023. The rules will apply in 137 countries and jurisdictions that are part of the OECD/G20 Inclusive Framework on Base Erosion and Profit Sharing (BEPS).

Double Taxation of Corporations

C corporations must pay a tax on their profits at the corporate rate, yet those profits are taxed again when they are distributed as dividends to shareholders and declared on shareholders’ personal income tax returns at their individual dividend tax rate. By contrast, S corporations avoid this double taxation by having their profits pass through to shareholders with no intermediate dividend payment. However, shareholders pay taxes on corporate income at the marginal tax of a shareholder, which is often higher.

Several techniques are available to corporate accountants that may prevent double taxation of corporations:

The major shareholders of many smaller corporations are often employees, so their earnings can be distributed as wages and fringe benefits rather than dividends — though the IRS sets a limit on how much of their earnings can be distributed this way. For example, the IRS will recategorize wages as constructive dividends if the wages are deemed to be unreasonably high. The corporation is then able to deduct the wages and benefits as business expenses on its income tax return.
Larger corporations whose shareholders aren’t employees may avoid double taxation by designating nonactive shareholders as “consultants” and paying them a wage as a tax-deductible business expense. They may also name shareholders to their board of directors.
When pension funds, charities and other tax-exempt investors are shareholders of a corporation, they are not required to pay taxes on the dividends they receive.

International corporations may also be subject to double taxation by having to pay taxes to more than one country: the country in which the money is earned and the company’s home country. Many countries have entered into treaties to prevent international firms from having to pay taxes on their profits. The agreements are often based on OECD models and are intended to promote trade between countries. The U.S. marginal tax rates are generally higher than foreign tax rates, so most firms will pay fewer taxes when they repatriate their earnings. Companies can also apply for a foreign tax credit.

The Impact of Double Taxation on Corporations

Proponents of double taxation claim that the practice is necessary to prevent wealthy corporate shareholders from paying no taxes on the dividends they receive in lieu of earning any personal income. Also, corporate dividend payments are voluntary, so corporations can move their double taxation obligation to a different time by not paying dividends.

Critics of double taxation of corporations claim that the practice reduces savings and investments and encourages firms to rely on debt financing over equity financing because of the higher cost of capital. Double taxation also discourages new business entities from choosing the C corporation structure.

At present, the double taxation of corporate profits is mitigated by the preferential tax rates on capital gains and dividends or exempting part of a shareholder’s income from full taxation. A record number of companies are turning to share repurchases as a way to increase their profit-per-share figure as share prices decline. Such stock buybacks signal to the market that the firm is in a strong financial position because it has sufficient cash on hand to repurchase the shares.

Corporate-Owned Life Insurance Taxation

The cash value of corporate-owned life insurance is not subject to federal income tax as it accumulates, which makes it a preferred form of nonqualified deferred compensation (NQDC). The corporation may be a full or partial beneficiary of the policy, which can insure an employee, a group of employees, an owner or a debtor. These policies are typically used to fund NQDCs.

The corporation purchases the cash value life insurance policy on individual employees and pays all premiums. As owner and beneficiary of the policy, the corporation retains all rights, including the policy’s cash value accrual and death benefits. In most cases, the accumulated cash value is not subject to federal income tax, yet companies can borrow against the policies to pay the premiums or to fund NQDCs. Some or all of the interest the company pays on a policy loan may be deducted.

Corporate Tax Accounting Salary Ranges

The U.S. Bureau of Labor Statistics (BLS) estimates that the median annual salary for accountants and auditors as of May 2020 was $73,560, ranging from less than $45,220 for the lowest 10% to more than $128,680 for the highest 10%.

The salary survey site PayScale reports that the median annual salary for corporate accountants and tax accountants specifically was about $58,000 as of January 2022. Skills that can enhance a tax accountant’s salary include international taxation (11% higher than the median), financial analysis (5% higher), payroll tax compliance (5% higher) and reconciliation (5% higher). The median salary of corporate accounts increases for those who possess skills such as budget management (17% higher than the median), budgeting (11% higher) and payroll administration (6% higher).

Tax Accountant Salaries by Industry and Experience Level

According to the BLS, the industries paying the highest wages to accountants and auditors are finance and insurance ($78,600 median salary annually as of May 2020) and management of companies and enterprises ($76,230). The areas hiring the most corporate accountants are accounting, tax preparation, bookkeeping and payroll services (25%), finance and industry (9%) and government (8%).

PayScale estimates that corporate accountants with between five and nine years of work experience earn 5% more than the median for all people in the position, while those with 10 to 19 years of experience have salaries that are 10% higher than the median. Tax accountants with five to nine years of experience earn about 10% more than the median, and those with 20 or more years of experience have salaries that are 17% higher than the median.

The Outlook for Tax Accounting Careers

The BLS forecasts that the number of jobs available for accountants and auditors will grow by 7% between 2020 and 2030, which is about as fast as the average job growth projected for all industries. Demand for corporate and tax accountants will be driven by globalization, general economic growth and continuing changes to tax laws and financial regulations. In particular, tax accountants with expertise in international trade and international mergers and acquisitions will be in great demand.

Typical career paths for tax accountants include positions such as senior tax accountant, tax manager, tax director and chief tax officer. Corporate accountants often move up to senior roles such as corporate controller, senior accountant, accounting manager and financial controller.

Preparing for a Career in Corporate Accounting

Reducing a corporation’s tax burden is a crucial contribution to the company’s financial success. Tax laws and regulations change constantly, which means a steady influx of tax accountants with expertise in corporate and international finance is required. Programs such as that of the University of Nevada, Reno’s online Master of Accountancy (MAcc) degree feature courses in corporate and international taxation as well as in taxation of other business entities that serve as the foundation for a successful career as a corporate tax accountant. Find out more about how the MAcc degree program prepares students for positions in corporate taxation.

Recommended Reading:

How to Become an Internal Auditor

7 Worst Accounting Scandals in U.S. History

Financial Accounting vs. Managerial Accounting: What’s the Difference?

Sources:

Bloomberg, “Accounting Methods Are Hot Topics for 2021 Tax Planning”

Bloomberg, What’s New in Tax & Accounting

Business News Daily, “Cash vs. Accrual Accounting Methods”

Center on Budget and Policy Priorities, Policy Basics: Federal Payroll Taxes

Forbes, “2022 U.S. Tax Legislation Forecast”

Fraser Stryker, “A Guide to Corporate-Owned Life Insurance”

Inc., “Double Taxation”