Legal Entity

• A corporation is a legal entity that exists independent of its owners and managers. As an independent legal entity, the corporation can sue or be sued, and it also has its own independent taxation obligations. When a corporation is formed, the corporation must obtain a federal tax ID number from the IRS. The IRS treats the corporation as an individual taxable entity.
  
  

Corporate Level Tax

• The first layer of corporate taxation occurs at the corporate-entity level. As a distinct legal entity, the corporation has income that is taxable by the IRS. The corporation itself pays the tax on its annual income. For practical purposes, the corporate-level tax is treated as an ordinary business expense. The corporate tax applies before any individual person takes any money from the corporation.
  
  

Tax Deferral

• As long as the corporation hangs onto the money that it earns, nobody pays an additional tax on that money. The corporation can hold that money in a bank account or purchase other property with that money, and as long as the corporation continues owning that property there is no additional tax. However, the second layer of taxation occurs as soon as somebody withdraws the money from the corporation.
  
  

Shareholders

• The owners of a corporation are called the shareholders. The corporation distributes profits to shareholders in the form of dividends. Each dividend is taxable income to the shareholder. The corporation does not pay this tax, but instead each shareholder includes the dividend as income on her personal tax return.
  
  

Wages

• The other way for a corporation to distribute its earnings to people is through the payment of wages to corporate employees. The wages are taxable income to each of these individuals. Like the dividend tax, the tax on wages is a personal tax that each income earner must pay to the IRS.