Newbie question
May 01, 2023
by a searcher in Chicago, IL, USA
I almost feel embarrassed asking these questions as a newbie to the business world, but here goes:
1. When looking at a company's Net profit, how much of that would be taxed Federally? I know there is also State tax to be subtracted depending where the business is. Let's say a business is doing $1M in profit. Is there a set rule for tax deduction?
2. If the company is paying a 500k per year loan, am I correct in assuming that only the interest portion of the loan is tax deductible? For example if the loan is at set at 5% interest, only 5% of the $500,000oan per yearis deductible? ($25,000). So that would reduce the Net profit to $925,000?
from Duke University in Virginia Beach, VA, USA
In general, yes the Net profit is what is taxable. Now that's a very broad brush stroke. And how that's taxed depends on how you're organized.
Now, major caveats to my statement "in general Net profit is what is taxable" (not exhaustive list):
- tax accounting is fundamentally different from financial accounting. Not all expenses are treated the same by the tax code as they are under standard financial accounting standards. So there can be significant variance.
- interest expense generally reduces your net profit and is taxed accordingly - in effect, "deductible". I think there are some new limitations on expensing interest related to the tax reform during the Trump administration.
- A smaller business will generally be taxed on a "tax basis". In other cases, businesses are taxed based on accrual basis. I don't know the rules regarding which you select, and I don't know the criteria for each, but these treatments can vary significantly.
Now regarding HOW they're taxed:
- S-corp election: the net profit "passes through" to the individual returns of the owners on a pro rata basis. The corporation/LLC does not itself pay taxes to the Federal Gov't. Usually the business makes distributions of capital to the owners so that they can cover their tax liabilities.
- C-corp: the corporation pays corporate taxes to the Fed Gov't at the corporate rate. Individuals only pay individual taxes on dividends / cap gains that they incur as an owner/seller.
I hope this helps a bit. I hope it's not wildly inaccurate. But I think at a high level this can help you understand how it works. Others feel free to find all kinds of fault with my analysis!
from State University of New York (SUNY) in Buffalo, NY, USA
Good contribution from Chris above to answer your first questions. To answer your second question, the amortization portion of a loan payments is not tax deductible. The way interest is calculated depends on the structure of the loan.
To make a simple example, let’s say you have a $500k loan that fully amortizes over 10 years with a 10% fixed rate. Your monthly payment will be ~$6.6k. In the first few years the portion of that payment that is for interest is higher and the portion that pays down principal is lower. So year 1 the interest expense is $48.6k and principal pay down is $30.7k. The $48.6k is tax deductible but the $30.7k is not. There are payment calculators online that can help you with this https://www.calculator.net/payment-calculator.html.