Problem 5 If an individual owns a corporat... [FREE SOLUTION]

Chapter 17: Problem 5

If an individual owns a corporation for which he is the only employee, which different types of federal tax will he have to pay?

Short Answer

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An individual who owns a corporation and is the only employee will typically pay personal income tax on their salary and dividends, corporate income tax on the corporation's profits, and be responsible for payroll taxes, which include Social Security and Medicare taxes (FICA) and federal unemployment (FUTA) tax. They are not subject to self-employment tax as they are considered an employee of the corporation.

Step by step solution

1. Personal Income Tax

The business owner should pay personal income tax on their salary and dividends from the corporation. Income tax is based on the individual's taxable income, which includes salary, dividends, interest, and other income sources. The individual will report the salary and other income on their personal income tax return (Form 1040) annually.

2. Corporate Income Tax

The corporation itself is subject to corporate income tax on its profits. The owner needs to file an annual corporate income tax return (Form 1120) and pay the necessary tax liabilities. It is important to keep in mind that the corporation's income tax is separate from the owner's personal income tax.

3. Self-Employment Tax

As the owner of the corporation and being the only employee, the individual is not subject to self-employment tax because they are considered an employee of the corporation, rather than being self-employed. However, if the owner decides to pay themselves as an independent contractor rather than an employee, they would then be subject to self-employment tax. Self-employment tax covers Social Security and Medicare taxes for self-employed individuals.

4. Payroll Taxes

If the owner is paying themselves as an employee, the corporation is responsible for payroll taxes. Payroll taxes include Social Security and Medicare taxes (FICA) and federal unemployment (FUTA) tax. The corporation must withhold FICA taxes from the owner's wages and pay a matching amount of FICA taxes. The corporation is solely responsible for the payment of FUTA taxes, which helps fund unemployment compensation programs for eligible workers. In summary, an individual who owns a corporation and is the only employee will typically pay personal income tax, corporate income tax, and be responsible for payroll taxes related to their salary.