What is an S Corporation and a C Corporation
One of the choices companies have to make whenever they decide to go into
incorporation is how they would want to be taxed. Thus the choice of whether to
start up an S Corporation or a C Corporation. The corporation can make this
choice at the beginning of their existence or at the beginning of the new tax year.
S Corporations, or what was formerly called as “Sub-section S Corporations”, do
not pay income taxes and are solely used for small businesses. Whatever the
company loses or gains within the year will be passed through the shareholders,
who in return will report this in their individual annual returns. The corporation
files an information return listing all of the company’s expenses, earnings, its
depreciation, and other financial matters at the end of each year. In accordance
to their individual stock percentage ownership, each shareholder is given a notice
of his or her share.
Using this status is quite advantageous because it avoids double taxation and
allows the company’s losses and depreciation to be passed-through, because the
business is treated as a partnership especially for taxation purposes. Due to the
cost of starting up a business, some corporations opt to be in the S status while
gradually switching to C Corporation status after a few years of operation.
Typically, S Corporations are not required to pay state corporate income taxes.
Some disadvantages of an S Corporation is in the case where shareholders come
from high income brackets, because they will be taxed at those rates. As for
shareholders who do not participate materially in the business, whatever loss that
have been incurred cannot be deducted. Fringe benefits like health and life
insurance, may not be tax deductible.
To qualify as an S Corporation status, corporations must meet the following
- They must be a domestic corporation
- They must have no more than one hundred (100) shareholders
- They must not be non-resident aliens or corporations
- They must only have one class of stock
- They must not be a member of any affiliated group (only individuals,estates, and certain organizations and trusts qualify for this one
- They must file for an IRS Form 2553 with the IRS before the end of the fifteenth day of the third month of the tax year of which it will take effectivity as approved by the IRS.
C Corporations pay taxes on its net earnings based on corporate rates. All salaries paid by the corporation to all its officers, directors, and employees are deductible to the corporation but taxable for the aforementioned people. Dividends that have been paid out are taxed twice, because it is taxed at the corporation’s rate as part of its profit, and it is taxed as income to the individual shareholder’s rate when the corporation distributes these to them.
This status is mostly advantageous for corporations whose shareholders belong to
a higher tax bracket than the corporation, taxes are saved and the money that is
left can be used for expansion of the company. Fringe benefits like health,
accident, and life insurance may be filed as deductible expenses.
The most notable disadvantage of this status is the matter of double taxation of
dividends. In most states they have an income tax that applies only to C
Corporations and all income it acquires up to a certain amount. What this means
is that any income earned by the company and profits paid out to its
shareholders, including salaries paid out to its directors, officers and employees
will be taxed accordingly.