Corporate tax rates, minimum taxes and penalty taxes

The federal tax rate on C corporations is simple: a flat 21 percent of taxable income under section 11, with no graduated brackets. The complexity lies elsewhere: in state corporate income taxes, in the special taxes that stop closely held corporations from being used to shelter income at the corporate rate, and in the minimum taxes that apply to very large corporations. This lesson explains the rate structure and its history, the deduction for state taxes, the accumulated earnings tax and the personal holding company tax, the corporate alternative minimum tax, the controlled group rules and corporate estimated tax, and computes the model Brandt Aerial corporation's 2027 federal and Iowa income tax.

The flat 21 percent rate

Section 11 imposes tax at 21 percent on the taxable income of every corporation. Before 2018, corporations paid graduated rates from 15 percent on the first $50,000 to 35 percent, with surtaxes that removed the lower brackets for larger corporations and a flat 35 percent rate for personal service corporations. The Tax Cuts and Jobs Act replaced all of that with a single rate, which the 2025 act left unchanged. Because the rate is flat, many rules that once mattered, such as the requirement that a controlled group share a single set of lower brackets, now matter only for the items that are still shared. A flat rate also means that the timing of deductions matters less for a C corporation than for an individual whose bracket changes from year to year, except where losses are limited.

State corporate income taxes

Forty-four states and the District of Columbia levy corporate income taxes, at top rates from about 2 to 11.5 percent, and a few levy gross receipts taxes instead. Most start from federal taxable income and then make their own adjustments, for example adding back bonus depreciation where the state has decoupled from it. A corporation doing business in several states apportions its income among them, most commonly today by a single sales factor; lesson 9 covers nexus and apportionment. Iowa taxes corporate income at 5.5 percent on the first $100,000 and 7.1 percent above that for tax years beginning in 2026; scheduled reductions did not take effect for 2026 because state revenue did not reach the trigger. Unlike individuals, whose deduction for state and local taxes is capped, a corporation deducts state income taxes in full as a business expense, which reduces the combined rate.

The small business deduction

Unlike Canada, the United States gives small C corporations no reduced rate. Instead, the main tax preference for small businesses runs through flow-through entities: the qualified business income deduction of section 199A, which the 2025 act made permanent at 20 percent, with wider phase-in ranges for the wage and property limits and a minimum $400 deduction from 2026 for taxpayers with at least $1,000 of qualified business income from active businesses. Small C corporations do benefit from simpler accounting rules, exemption from the business interest limit and the possibility of a section 1202 exclusion for their shareholders on a sale. A personal service corporation pays the same 21 percent rate as other corporations, but its owner-employees must still be paid reasonable compensation, and the passive activity rules restrict the losses it can deduct.

Special taxes on closely held corporations

Because the 21 percent corporate rate is lower than the top individual rates, the Code has long contained two penalty taxes to stop owners from leaving profits in a corporation simply to avoid personal tax. The accumulated earnings tax of section 531 is 20 percent of accumulated taxable income, roughly the year's taxable income adjusted toward economic income, minus dividends paid and an accumulated earnings credit. The credit lets every corporation accumulate at least $250,000 ($150,000 for corporations whose principal function is services in health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting) and more if it can show reasonable business needs, such as working capital, expansion, debt retirement or self-insurance. The personal holding company tax of section 541 is 20 percent of undistributed personal holding company income. It applies if five or fewer individuals own more than half of the stock by value at any time during the last half of the year and at least 60 percent of adjusted ordinary gross income is passive income such as dividends, interest, royalties and certain rents, or income from personal service contracts that name a 25 percent shareholder. Both taxes are avoided by paying dividends.

Two other regimes affect larger corporations. The corporate alternative minimum tax, enacted in 2022, imposes a 15 percent minimum tax on adjusted financial statement income for corporations whose average annual adjusted financial statement income over three years exceeds $1 billion (or $100 million for US members of foreign-parented groups above the $1 billion test). The base erosion and anti-abuse tax applies to corporations with average gross receipts of $500 million or more that make large deductible payments to foreign related parties; the 2025 act set its rate at 10.5 percent for tax years beginning after 2025. Members of a controlled group of corporations must share certain items, such as one accumulated earnings credit and the section 179 limit, and aggregate their gross receipts for the small business tests.

Whether a C corporation's 21 percent rate is attractive depends on what happens to the profits next. If they are reinvested in the business for many years, the corporation defers the difference between 21 percent and the owner's marginal rate, and on a sale the shareholder may exclude gain under section 1202. If they are paid out each year, the second layer of tax usually makes the C corporation more expensive than a pass-through. Many owner-managed C corporations therefore pay out most of their profit as deductible salaries and bonuses, but the IRS can challenge compensation that is unreasonably high and treat the excess as a nondeductible dividend: the mirror image of the S corporation problem of compensation that is too low. Lessons 4, 5 and 11 return to these choices.

The model corporation's federal and Iowa tax

The program computes the model corporation's 2027 Iowa and federal income tax from the taxable income determined in lesson 2, applying the 2026 rates. It assumes Iowa taxable income equals federal taxable income before the deduction for state tax, a simplification, then deducts the Iowa tax in computing federal tax. It also projects the corporation's accumulated earnings if it keeps most of its profits, and confirms that the corporate alternative minimum tax does not apply.

# Brandt Aerial as a C corporation: federal and Iowa income tax for 2027 using 2026 rates
taxable = 107_836
federal = 0.21 * taxable

def iowa_corporate(x):
    """Iowa corporate rates for tax years beginning in 2026: 5.5% to $100,000, 7.1% above."""
    return 0.055 * min(x, 100_000) + 0.071 * max(0, x - 100_000)

state = iowa_corporate(taxable)           # assumes Iowa taxable income equals federal
deductible_state = state                  # state income tax is deductible federally
federal_after = 0.21 * (taxable - deductible_state)
print(f"Federal taxable income before state tax       {taxable:>11,.2f}")
print(f"Iowa corporate income tax                     {state:>11,.2f}")
print(f"Federal tax after deducting Iowa tax (21%)    {federal_after:>11,.2f}")
print(f"Combined federal and Iowa tax                 {federal_after + state:>11,.2f}")
print(f"Combined rate on income before both taxes     {(federal_after + state) / taxable:.2%}")
print()
# Accumulated earnings tax: 20% on accumulated taxable income beyond reasonable needs;
# the minimum credit shelters $250,000 of accumulated earnings ($150,000 for listed service fields)
retained = [86_000, 140_000, 190_000, 240_000]
total = 0
for yr, r in zip(range(2027, 2031), retained):
    total += r
    over = max(0, total - 250_000)
    print(f"{yr}: accumulated earnings {total:>9,}  above the $250,000 credit {over:>9,}")
print("Above the credit, the corporation must show reasonable business needs or face 20% AET.")
print()
print("Corporate alternative minimum tax applies only if average annual adjusted financial")
avg_afsi = 120_000
print(f"statement income exceeds $1 billion; Brandt Aerial's is about {avg_afsi:,}: CAMT does not apply.")

Federal taxable income before state tax        107,836.00
Iowa corporate income tax                        6,056.36
Federal tax after deducting Iowa tax (21%)      21,373.73
Combined federal and Iowa tax                   27,430.08
Combined rate on income before both taxes     25.44%

2027: accumulated earnings    86,000  above the $250,000 credit         0
2028: accumulated earnings   226,000  above the $250,000 credit         0
2029: accumulated earnings   416,000  above the $250,000 credit   166,000
2030: accumulated earnings   656,000  above the $250,000 credit   406,000
Above the credit, the corporation must show reasonable business needs or face 20% AET.

Corporate alternative minimum tax applies only if average annual adjusted financial
statement income exceeds $1 billion; Brandt Aerial's is about 120,000: CAMT does not apply.

Iowa tax is $6,056.36, and deducting it reduces federal tax to $21,373.73, so the combined rate is about 25.4 percent rather than the 26.5 percent the two statutory rates would suggest. The projection shows why the accumulated earnings tax matters to owner-managed C corporations: if Brandt Aerial kept most of its profits, its accumulated earnings would pass the $250,000 credit in 2029, after which the IRS could assess the 20 percent tax on accumulations it could not justify by business needs. Plans for new equipment, a second crew or a building, documented in board minutes, are the usual defense. The corporate alternative minimum tax is irrelevant to a business of this size.

Corporate estimated tax

Corporations must pay estimated tax in four installments, due on the 15th day of the 4th, 6th, 9th and 12th months of the tax year (15 April, 15 June, 15 September and 15 December for a calendar-year corporation), if they expect to owe $500 or more. Each installment should be 25 percent of the lesser of the current year's tax and the prior year's tax, but the prior-year safe harbor is unavailable if the prior year was a short year or showed no tax, and a large corporation (one with taxable income of $1 million or more in any of the three preceding years) can use the prior-year amount only for its first installment. Underpayments bear an addition to tax computed like interest. A new corporation such as the model Brandt Aerial must therefore estimate its first year's tax carefully.