IRS Publication 542, Corporations, is the agency’s core reference for domestic corporations dealing with federal income tax. It supplements the instructions for Form 1120 and walks through how corporations are classified, how taxable income is calculated, how transactions between a corporation and its shareholders are treated, what estimated payments and returns are due, and what happens when a corporation liquidates.1Internal Revenue Service. IRS Publication 542 – Corporations The flat 21% corporate tax rate applies to all C corporation taxable income, so the classification and deduction rules the publication explains reach every dollar a corporation earns or distributes.2GovInfo. 26 U.S. Code 11 – Tax Imposed
What Publication 542 Covers
Publication 542 is written for C corporations, which are separate taxable entities. A C-Corp files its own return, pays tax at 21% on its taxable income, and its shareholders pay tax again when profits are distributed as dividends. That two-layer structure is the defining feature of C-Corp status.
S corporations are outside the publication’s main focus. An S-Corp generally pays no federal income tax at the corporate level; each shareholder reports a share of the corporation’s income, losses, deductions, and credits on a personal return, and the character of each item carries through as the corporation earned or incurred it.3Office of the Law Revision Counsel. 26 U.S. Code 1366 – Pass-Thru of Items to Shareholders Eligibility is narrow. The corporation must be domestic with no more than 100 shareholders, and shareholders must be individuals, certain trusts, or estates; partnerships, other corporations, and nonresident aliens cannot hold stock. Only one class of stock is allowed, though voting rights can differ.4Office of the Law Revision Counsel. 26 U.S. Code 1361 – S Corporation Defined Certain corporations are ineligible regardless, including financial institutions using the reserve method for bad debts, insurance companies taxed under Subchapter L, and DISCs. Electing S status requires every shareholder to consent and Form 2553 to be filed no later than two months and 15 days into the tax year the election is meant to take effect.5Internal Revenue Service. Instructions for Form 2553
How Corporate Taxable Income Is Calculated
A corporation’s taxable income begins with gross income from all sources and is reduced by ordinary business deductions such as salaries, rent, interest, and depreciation. Depreciation and amortization are claimed on Form 4562.6Internal Revenue Service. About Form 4562, Depreciation and Amortization Because book accounting and tax accounting treat many items differently, corporations reconcile financial income with taxable income on Schedule M-1 of Form 1120. Corporations with $10 million or more in total assets file the more detailed Schedule M-3 instead.
A new corporation can write off up to $5,000 of startup costs and an additional $5,000 of organizational costs in its first year. Each $5,000 allowance phases out dollar-for-dollar once the respective costs exceed $50,000 and disappears entirely at $55,000. Whatever isn’t deducted immediately is amortized over 180 months starting the month the business begins active operations.7eCFR. 26 CFR 1.195-1 – Election to Amortize Start-Up Expenditures
Deductions reduce taxable income; credits reduce tax owed. The General Business Credit on Form 3800 aggregates dozens of individual credits, and its use is limited by the corporation’s tax liability.8Internal Revenue Service. About Form 3800, General Business Credit Unused credits can carry back one year and forward up to 20 years depending on the specific credit.
Dividends Received Deduction
When one corporation owns stock in another domestic corporation, the same earnings could otherwise be taxed at three levels. The Dividends Received Deduction cuts that chain, and the percentage depends on ownership:
- Less than 20% ownership: 50% of dividends received are deductible.
- 20% to less than 80% ownership: 65% of dividends received are deductible.
- 80% or more ownership (affiliated group member): 100% of dividends received are deductible. Small business investment companies operating under the Small Business Investment Act also qualify for the 100% deduction regardless of ownership level.
The figures come from Section 243.9Office of the Law Revision Counsel. 26 U.S. Code 243 – Dividends Received by Corporations At the 50% and 65% tiers the deduction is capped at that same percentage of the corporation’s taxable income, computed without regard to net operating losses, capital loss carrybacks, and certain other items. That ceiling disappears in any year where claiming the full deduction would create or increase a net operating loss.10Office of the Law Revision Counsel. 26 U.S. Code 246 – Rules Applying to Deductions for Dividends Received
Net Operating Losses and Capital Losses
When deductions exceed income, the resulting net operating loss carries forward indefinitely to offset future taxable income. Under rules made permanent by the Tax Cuts and Jobs Act, the NOL deduction in any given year is limited to 80% of that year’s taxable income, and carrybacks are no longer available for most C corporations. A bad year no longer generates a refund from prior years’ taxes.
Corporate capital gains receive no preferential rate; they are taxed at the same 21% as ordinary income. Capital losses may only offset capital gains. If capital losses exceed capital gains, the excess carries back three years and forward five years to be applied against net capital gains in those periods.11Office of the Law Revision Counsel. 26 U.S. Code 1212 – Capital Loss Carrybacks and Carryovers
Dealings Between the Corporation and Its Shareholders
Publication 542 pays close attention to how the IRS treats financial dealings between a corporation and its owners. The central concept is the constructive dividend. If a corporation provides a shareholder a financial benefit that isn’t structured as formal compensation or a declared dividend, the IRS may reclassify the benefit as a taxable dividend.
Common triggers include the corporation paying a shareholder’s personal debts, letting a shareholder use corporate property without charging fair rent, or paying a shareholder-employee more than a third party would accept for the same work.12Internal Revenue Service. Topic No. 404, Dividends and Other Corporate Distributions Below-market loans from the corporation to a shareholder are another frequent trigger: the IRS imputes interest and treats the forgone interest as a distribution.
Accumulated Earnings Tax
C corporations that stockpile profits beyond what the business reasonably needs can face a 20% accumulated earnings tax on top of the regular corporate tax. Every C-Corp gets an accumulated earnings credit, which for most corporations covers the first $250,000 of accumulated earnings, or $150,000 for personal service corporations such as accounting and consulting firms. Amounts above that credit must be justified by specific, concrete business needs like planned equipment purchases, expansion, or debt retirement. Vague claims about future growth rarely survive an audit.
Filing, Extensions, and Estimated Payments
A C corporation files its annual return on Form 1120. It is due on the 15th day of the fourth month after the corporation’s tax year ends, which lands on April 15 for calendar-year filers. An S corporation uses Form 1120-S, with an earlier deadline: the 15th day of the third month, or March 15 for calendar-year filers.13Internal Revenue Service. Publication 509 (2026), Tax Calendars S-Corps must also give each shareholder a Schedule K-1 by that same date.
Either type of corporation can request an automatic six-month extension by filing Form 7004 before the original due date.14Internal Revenue Service. About Form 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns The extension buys time to file, not time to pay. Tax owed is still due by the original deadline, and interest runs on any unpaid balance from that date.
A corporation expecting to owe $500 or more must make quarterly estimated tax payments.15Internal Revenue Service. Estimated Taxes For a calendar-year corporation, installments are due April 15, June 15, September 15, and December 15, and each generally equals 25% of the required annual payment.16Office of the Law Revision Counsel. 26 U.S. Code 6655 – Failure by Corporation to Pay Estimated Income Tax To avoid a penalty, a corporation must pay at least 100% of its current-year tax liability through these installments, or 100% of the prior year’s tax if a return was filed for a full 12-month year. Large corporations, defined as those with taxable income of $1 million or more in any of the three preceding years, cannot rely on the prior-year method after the first installment. All federal tax deposits must be made electronically, most commonly through EFTPS.
Penalties for Late Filing, Payment, and Deposits
The failure-to-file penalty is 5% of unpaid tax for each month or partial month a return is late, capped at 25%. The failure-to-pay penalty is a separate 0.5% per month on unpaid tax, also capped at 25%. When both apply in the same month, the filing penalty drops by 0.5%, so the combined hit is 5% per month rather than 5.5%.17Internal Revenue Service. Failure to File Penalty For returns more than 60 days late, the minimum penalty for tax years filed in 2026 is the lesser of the tax due or $525.18Internal Revenue Service. Instructions for Form 1120
Late deposits carry tiered penalties based on how many calendar days the payment is overdue:
- 1 to 5 days late: 2% of the unpaid deposit.
- 6 to 15 days late: 5% of the unpaid deposit.
- More than 15 days late: 10% of the unpaid deposit.
- More than 10 days after an IRS notice demanding payment: 15% of the unpaid deposit.
The tiers replace each other rather than stacking, so a deposit 20 days late incurs 10%, not 17%.19Internal Revenue Service. Failure to Deposit Penalty Underpayment of estimated tax is calculated separately on Form 2220, and the penalty functions as interest at the IRS underpayment rate on the shortfall for each installment period.20Internal Revenue Service. Instructions for Form 2220
Dissolution and Liquidation
When a corporation winds down and distributes its remaining assets to shareholders in exchange for their stock, tax consequences fall on both sides. Within 30 days of adopting a plan of dissolution or liquidation, the corporation must file Form 966.21eCFR. 26 CFR 1.6043-1 – Return Regarding Corporate Dissolution or Liquidation
The liquidating corporation recognizes gain or loss on every asset it distributes as though it sold that asset to the shareholder at fair market value, so built-in appreciation triggers corporate-level tax even without an actual sale.22Office of the Law Revision Counsel. 26 U.S. Code 336 – Gain or Loss Recognized on Property Distributed in Complete Liquidation The major exception is the complete liquidation of a subsidiary where the parent owns 80% or more of the stock; the parent recognizes no gain or loss on the liquidating distributions, and the subsidiary generally doesn’t either.
On the shareholder side, a liquidating distribution is treated as payment in exchange for stock rather than as an ordinary dividend. The shareholder recognizes capital gain or loss equal to the difference between the fair market value of what is received and the adjusted basis in the stock, with long-term or short-term character depending on the holding period.23Office of the Law Revision Counsel. 26 U.S. Code 331 – Gain or Loss to Shareholder in Corporate Liquidations The shareholder’s tax basis in the property received becomes its fair market value on the distribution date.
The corporation must file Form 1099-DIV for any shareholder receiving $600 or more in liquidating distributions. Cash liquidation amounts go in Box 9; noncash distributions at fair market value go in Box 10.24Internal Revenue Service. Instructions for Form 1099-DIV The final Form 1120 reports all gains and losses from the asset distributions and closes out the corporation’s tax reporting obligations.