Understanding US Corporate Income Taxation
The best way for UK clients to gain quick understanding of the US corporate income tax system is to review how the US corporate income tax differs from the UK corporation tax. Although the two systems are in many respects similar, there are some distinctions. Here are the main ones:
- Jurisdiction to tax. Whereas in the UK corporation tax is imposed and collected solely by HMRC, in the US the power to assess corporate income tax is jointly shared by multiple taxing jurisdictions. The federal government imposes a corporate income tax, as do 44 US states. Three US states (Nevada, South Dakota, and Wyoming) have no corporate tax whatsoever. Three states (Ohio, Texas, and Washington) impose a tax on corporate gross receipts, rather than income. A few cities (e.g., New York and Los Angeles) also impose their own corporate income taxes.
- The rate. The current UK corporation tax rate is 19%. In the US, federal corporate income tax rates have traditionally been progressive, with higher marginal rates for higher taxable income. However, as a result of legislation adopted in late 2017 and effective in 2018, the federal corporate income tax is now imposed at a flat rate of 21%. In addition, in the 44 states with corporate income taxes, rates range from 3% (North Carolina) to 12% (Iowa). In the few cities that impose corporate income taxes, the rate is typically between 1% and 3%, although the rate for New York City is substantially higher.
- Filing of tax returns and payment of taxes owed. As in the UK, a US corporation can choose when its financial year will end. In the UK, the Company Tax Return is due 12 months after the end of this financial year. In the US, the corporate income tax return is due on the 15th day of the 4th month after the tax year closes (although a 6-month extension is automatically given upon request). In the UK, corporation tax owed generally must be paid within nine months and one day after the end of its accounting period, with quarterly instalments due only when the company’s annual profit exceeds £1.5 million. In the US, corporations which expect to have tax due of $500 or more must make quarterly estimated tax payments. As long as the tax owed is paid in full by the un-extended due date of the return, the failure to make quarterly estimated tax payments will only result in the imposition of a modest penalty (currently 4% of the underpayment).
- Cash basis accounting. In the UK, cash basis accounting is not available to limited companies. Even among sole traders or partnerships, it is unavailable where annual turnover exceeds £150,000. In the US, in contrast, cash basis accounting is more widely accepted. Generally, a US corporation can use cash basis accounting if it has average annual gross receipts during the prior three years of under $25 million.
- Annual investment allowance. In the UK, the annual investment allowance (AIA) permits UK companies to immediately deduct the cost of business assets that otherwise would be subject to capital allowances. The current maximum annual investment allowance is £200,000 per year. In the US, this immediate deduction for expenses incurred to acquire business assets is known as the “Section 179 deduction.” The Section 179 deduction is currently available for up to $1,000,000 of purchases for businesses with under $2.5 million in capital purchases. The Section 179 limit phases out beyond $2.5 million in capital purchase. In addition, once the Section 179 deduction is exhausted, a corporation can claim an immediate deduction of up to 100% of the remaining cost of certain qualifying property.
- Treatment of capital allowances. In the UK, if the business asset does not qualify for AIA or the AIA has been exhausted, the business may still be able to write off the cost of the assets through capital allowances. In the US, capital allowances are known as depreciation deductions. Where the Section 179 deduction is unavailable or has been exhausted, the cost to acquire business assets is written off over the asset’s “class life.” Each asset is assigned to a category and corresponding class life. For example, automobiles and computers are written off over 5 years, whereas non-residential real property is written off over 39 years. For most assets, the write off is accelerated (under a system known as “MACRS”), so that larger write-offs are permitted in the earlier years of the class life than in the later years.
- Balancing charges. In the UK, when an asset is disposed the proceeds received are deducted from the pool to which the asset was originally allocated to determine whether a balancing charge will result. In the US, in contrast, Section 179 deductions and/or depreciation deductions are applied to individual assets to determine whether there is depreciation recapture. Depreciation recapture occurs when an asset is sold for an amount that exceeds that asset’s adjusted basis (which, generally, is the cost of the asset minus any accumulated tax depreciation plus the cost of any improvements to the asset). The difference between the proceeds from sale and the asset’s adjusted basis must be included in income in the year of sale.
- Trading Loss Relief. In the UK, trading losses can be carried back against profits in the preceding 12 months or applied to future profits. Generally, in the US, corporate losses must first be carried back two years, then carried back one year. However, losses incurred in 2018 or thereafter may not be carried back. Subject to some limitations, any loss that is not exhausted after being carried back may be carried forward for up to 20 years.