Which legal structure is right for your new business, C Corp or S Corp status? Taxation is often considered the most significant difference for small business owners. C corps are separately taxable entities. S corps are pass-through tax entities. With both, personal income tax is due on any salary drawn from the corporation and from any dividends received from the corporation.
C Corp or S Corp. What’s the difference?
The main difference between setting your business up as a C Corp or S Corp is the tax structuring and how that will affect the tax consequences of the owners of the business. Owners sitting on the high side of their individual tax brackets might want a newly-formed business to shift any tax burden to the business. An owner with another agenda might not think the same way.
What are some of the interesting aspects of a C Corp?
Unlike most other business structures, C Corps are taxable entities. This means that the corporation gets taxed on its income and files a corporate tax return. Taxes don’t just NOT happen. Other business structures could pass the income on to the owner, or owners, who are then taxed on that income.
If you don’t plan to distribute all of the profits, structuring your new business as a C Corp and utilizing a strategy known as “income splitting” might be your best route. In this scenario, business income is split, part of it is taxable to the corporation, and part of it is taxable to the corporation’s owner, or owners. Benefits? The owners are each possibly put in a lower tax bracket than they’d be if any one of the owners were earning all of the income.
The big disadvantage to C Corp taxation is that distributions of profits (known as “dividends”) are subject to double taxation. In other words, the corporation is taxed once on its income, and then the shareholders are taxed upon any dividends they receive.
Also, C Corp businesses, (along with their S Corp buddies) are more complicated from an accounting, tax, and legal standpoint than sole proprietorships, partnerships, or LLCs. As such, C Corp owners tend to incur fairly high legal and accounting costs. Ouch! But, depending on the needs of the owner, or owners, strategically shifting tax liability could offset that Ouchy and with the option of multiple stock classes.
S Corp structures have some pretty cool advantages, too!
Structure your business as an S Corp, and you see the immediate benefits in the form of tax savings and less confusion. As pass-through tax entities, an S Corp files an informational federal return, but no income tax is paid at the corporate level. You’ll also see some tax savings as a result of the fact that profits from an S Corp are not subject to self-employment tax. But, before you can distribute any profits, you’ll have to pay any owner-employees a “reasonable salary” which is subject to Social Security and Medicare taxes. As such, the tax savings only take effect once the business has a pretty sizable income.
Another note here, by default a corporation is generally considered a C Corp. If you choose to be taxed as an S Corp, you must file IRS 2553 to inform the IRS that the shareholders have elected this tax status.
Let’s look at this final question: What is the key difference or critical distinction between the C Corp or S Corp structure?
An S Corp generally passes its taxable income or loss directly through to the shareholders while a C Corp will pay taxes on the corporate income directly.
Bottom line: C Corp or S Corp?
As your CPA and tax professional, we take care of the business of your business. We know this stuff and can help you make a qualified decision, so let’s talk about this. It’s your business and we’re here to help you. C Corp or S Corp. We’ll do it together.
Contact Melanie Radcliff CPA, Inc.
Call 479.478.6831 or send us an email