One of the most important decisions you’ll make when starting a business is choosing the right business entity. It’s a decision that impacts many things–from the amount of taxes you pay to how much paperwork you have to deal with and what type of personal liability you face. So far in this series I have discussed Sole Proprietorships, Partnerships and Limited Liability Companies (LLC). This month we take a look at C-Corporations and S-Corporations.
C-Corporations. In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation’s capital stock. A corporation conducts business, realizes net income or loss, pays taxes, and distributes profits to shareholders.
A corporate structure is more complex than other business structures. When you form a corporation, you create a separate tax-paying entity. The profit of a corporation is taxed to the corporation when earned and then is taxed to the shareholders when distributed as dividends, which creates a double tax (aka “double taxation”).
The corporation does not get a tax deduction when distributing dividends to shareholders. Earnings distributed to shareholders as dividends are taxed at individual tax rates on their personal tax returns. Shareholders cannot deduct any loss of the corporation.
If you organize your business as a corporation, you generally are not personally liable for the debts of the corporation, although there may be exceptions under state law.
S-Corporations. An S-corporation has the same corporate structure as a standard corporation; however, its owners have elected to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations generally have limited liability.
Generally, an S-Corporation is exempt from federal income tax other than tax on certain capital gains and passive income. It is treated in the same way as a partnership, in that generally, taxes are not paid at the corporate level. S-Corporations may be taxed under state tax law as regular corporations or other ways.
Shareholders must pay tax on their share of corporate income, regardless of whether it is actually distributed. Flow-through of income and losses is reported on their personal tax returns and are assessed tax at their individual income tax rates, allowing S-Corporations to avoid double taxation on the corporate income.
To qualify for S-Corporation status, the corporation must meet a number of requirements. Please call if you would like more information about which requirements must be met to form an S-Corporation.
Seek Professional Guidance
When making a decision about which type of business entity to choose each business owner must decide which one best meets his or needs. One form of business entity is not necessarily better than any other and obtaining the advice of a tax professional is critical. If you need assistance figuring out which business entity is best for your business, don’t hesitate to call.
Choosing the Correct Business Entity, Part 3
