Taxable Income

Corporations earn income in a variety of ways.  Regardless of the source, all of this income flows into a pool and is taxed using eight tax brackets (shown below).

Sources of Income

Income that flows into the pool may come from a variety of sources, e.g., income from selling a product or service, sale of the company's assets, sale of financial securities, or dividends received from an investment in another company.  Let's see how each of these are treated.

1.  Ordinary Income (income from selling a product or service)

All ordinary income (i.e., revenues minus expenses) is fully taxable; there are no adjustments.  All of the ordinary income flows into the pool.

2.  Dividends

Only a portion of received dividends is taxable to a corporation; how much is taxed depends on how much stock has been purchased.  For example, assume that company ABC has purchased some of company XYZ's common stock.  If ABC receives dividends on the investment, only some of the dividends will go into the pool to be taxed.  This amount depends on the percentage of XYZ's stock that ABC owns.  For example,

Be careful!  Notice that this procedure does not give you the tax owed on the dividends; rather it gives you the taxable portion of the dividends (i.e., the amount of dividends that flows into the pool and are taxable along with other income).

3.  Sale of Securities

If a company sells financial securities (stocks, bonds, etc.) for more than they paid for them, all of the gain is taxable.  If the securities are sold for less than they cost, then a loss (i.e., a negative gain) goes into the pool

4.  Sale of Depreciable Assets (also known as recapture of depreciation)

If you sell a fixed asset that you have been depreciating, you have to compute the gain or loss in a two-step process.  The gain or loss goes into the pool to be taxed.

Total Taxable Income

To determine the total taxable income, simply add the income from the various sources:

   Ordinary income
+ Taxable dividends
+ Gain on sale of securities
+ Gain on sale of depreciable asset
   Total taxable income

The total taxable income is then taxed at the rates shown in the next section.

Tax Brackets

The tax brackets for a corporation are as follows:

TAX PROBLEM (with a step-by-step solution)

Here is a tax problem that contains these four types of income:

McCormick Thoroughbreds, a successful thoroughbred racehorse farm, earned ordinary income from operations of $22,077,343 last year.

During the year, the company sold some equipment for $380,000.  McCormick had been depreciating the machine over a five-year depreciation period using the MACRS method.  When the machine was purchased two years earlier, its cost was $400,000.

McCormick Thoroughbreds also sold some marketable securities that it had been holding for several years.  The selling price was $210,000; the securities had been purchased originally for $195,000.

McCormick also received $18,000 of dividends from a company that was 4% owned by McCormick Thoroughbreds.

Calculate the taxes owed for the year.

THE SOLUTION

Step 1.  Calculate the Accumulated Depreciation on the Old Asset

In order to calculate the tax on the sale of the depreciable asset, we need to know its accumulated depreciation.  The depreciable cost of the asset is $400,000.  After 2 years, using the MACRS table, the accumulated depreciation would be $208,000 as shown below: 

Step 2.  Calculate the Taxable Income

 Step 3.  Calculate the Taxes Owed

Links to Related Topics

MACRS Table

Sample Tax Problem (Kelly's Krafts)

Sample Tax Problem (Yellow Brick Road, Inc.)