Question

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

The individual in this scenario, who owns a corporation and is its only employee, would be subject to the following types of federal taxes: corporate income tax, Social Security and Medicare taxes (FICA, as both the employer and employee), Federal unemployment tax (FUTA, as the employer), and personal income tax on any salary received from the corporation.

Step-by-step solution

Identify corporate taxes

A corporation is a separate legal entity, and as such, it is subject to corporate income tax. This tax is levied on the corporation's profits, which consist of the revenues it earns minus allowable expenses. The corporation needs to pay this tax regardless of the number of employees it has.

Identify employment taxes

Employment taxes are relevant to this scenario because the individual is both the employer and the employee of the corporation. The following employment taxes typically apply: 1. Social Security and Medicare taxes (FICA): Both the employer and the employee contribute to these taxes. As this individual is both the employer and the employee within the corporation, they are responsible for both portions of this taxation. 2. Federal unemployment tax (FUTA): Employers are responsible for paying FUTA tax, which contributes to the national unemployment insurance system. In this scenario, the individual is considered the employer and is therefore responsible for this tax.

Identify personal income taxes

Since the individual is also an employee of the corporation, he will be subject to personal income tax. This tax is based on the income received from the corporation and any other sources of income. In summary, the individual in this scenario would be subject to corporate income tax, Social Security and Medicare taxes (FICA), Federal unemployment tax (FUTA), and personal income tax.

Key concepts

Corporate Income Tax

Corporate income tax pertains to the taxation of a corporation's profits. This means that the revenue earned by a corporation is reduced by its allowable expenses, such as operating costs and salaries, and the remaining profit is subject to this tax. It's important to understand that corporations are taxed as separate legal entities distinct from their owners or shareholders.

For an individual who owns and is the sole employee of a corporation, the company must pay corporate income tax regardless of the owner's personal tax situation. The rate at which the corporation is taxed can vary depending on the current tax laws and the amount of income the corporation reported.

Employment Taxes

Employment taxes are crucial for both employers and employees. These taxes fund various public programs and consist of two main categories: those paid by the employer for having employees and the withholding taxes taken from an employee’s paycheck.

An individual who is both the employer and the employee of their corporation is accountable for both sides of these taxes. This unique situation ensures that the necessary contributions are still made to systems that benefit all workers, including the owner-employee.

Social Security and Medicare Taxes (FICA)

The Federal Insurance Contributions Act (FICA) is responsible for the collection of Social Security and Medicare taxes, which are fundamental to the United States' social safety net. Employers and employees generally share these taxes equally.

For a solo corporation owner, they must contribute twice—once as an employee and once as an employer. Contributions fund retirement benefits, disability benefits, and healthcare for seniors, ensuring that individuals are supported when they can no longer work due to age or disability. It's essential to remember that the rates for these taxes can change, so keeping current on the laws each tax year is important.

Federal Unemployment Tax (FUTA)

The Federal Unemployment Tax Act (FUTA) tax is paid by employers to fund unemployment insurance for workers who have lost their jobs. Unlike FICA, FUTA is paid only by the employer and is not deducted from the employee’s wages.

In the case where an individual owns a corporation and is the only employee, the corporation—on behalf of the owner—must pay FUTA tax. This payment supports the broader workforce system, providing temporary assistance to those in between employment.

Personal Income Tax

Personal income tax is a tax that individuals pay on their earnings, which includes wages, interest, dividends, and other forms of income. For the person who is both the owner and the sole employee of a corporation, they must pay personal income tax on the salary they receive from their corporation.

This tax is separate from the corporate income tax the corporation pays on its profits. It is critical to ensure that personal income taxes are filed accurately, taking into account all the income sources and the tax regulations that apply to those sources, as well as accounting for any deductions or credits for which the individual may be eligible.