A traditional corporation, known as a C-corporation, is taxed as a separate entity, leading to double taxation of corporate income and dividends to shareholders. An S-corporation, on the other hand, is a corporation that elects to be treated as a pass-through entity (such as a sole proprietorship or partnership) for tax purposes. Since all corporate income is "passed through" directly to the shareholders who include the income on their individual tax returns, S-corporations are not subject to double taxation. Moreover, the accounting for an S-corporation is generally easier than for a C-corporation. There are, however, certain restrictions placed on S-corporations:
- The S-corporation must not have more than 100 stockholders, and each of them must consent. (A married couple is treated as one stockholder).
- Each stockholder must be an individual who is a citizen or resident of the United States, or an estate or qualifying trust of such person.
- The corporation must have only one class of stock. (However, voting differences within a class of stock are permissible). Preferred stock is not allowed.
- The corporation must use the calendar year as its fiscal year unless it can demonstrate to the IRS that another fiscal year satisfies a business purpose.
Corporations wishing to become an S-corporation must file a Form with the IRS, and each stockholder of the corporation must sign the form.
If the number of shareholders in your corporation is small, you may think that becoming an S-Corporation is the right move, but you should weigh the advantages and disadvantages first.
Advantages of S-Corporation Status
One of the main advantages of S-Corporation status is that it avoids the double taxation that occurs with a regular C-Corporation. In a C-corporation, the corporation pays income tax on its profits and, if those profits are distributed to shareholders, the shareholders pay income tax on the distribution.
Electing S-Corporation status passes the income or losses of the corporation to the shareholders who recognize the income or loss on their personal tax returns. This is an advantage if the corporation expects to show a loss at first. The loss can be used to offset the shareholder's income from other sources, including a spouse's income.
Disadvantages of S-Corporation Status
Passing income through to shareholders can be a disadvantage in some instances. If the business is profitable, shareholders will be required to pay income tax on their share of the profits, even if that money is not distributed to them. In a C-Corporation, profits can be used to expand the business and shareholders are not required to pay taxes until distributions are made.
Reasonable salaries paid to employees are deductible business expenses for S-Corporations as well as for C-corporations. However, in an S-Corporation, fringe benefits may not be deductible as they would be in a C-Corporation.
Even though losses pass through to shareholders in an S-Corporation, those losses aren't deductible by shareholders who don't materially participate in the business. This could result in higher taxes overall.
S-Corporation Requirements
Not every corporation qualifies for S-Corporation status. In order to elect S-Corporation status, the corporation can only have one class of stock. The corporation can have no more than 35 shareholders, although a husband and wife who both own shares will only be counted as one shareholder. No shareholder can be a nonresident alien or another corporation. All of the shareholders must consent to elect S-Corporation status. The corporation also cannot earn too much of income from investments.
If you think an S-Corporation election makes sense for your corporation, see an attorney who practices in the area of business law. The attorney can explain to you how the advantages and disadvantages of S-Corporation status will impact your particular business.
If you're incorporating your small business you may have heard that you should incorporate as an "S-Corporation." Whether this is true or not depends on your situation and what you expect from your business.
An S-Corporation is a corporation that has made an election under subchapter S of the Internal Revenue Code that allows for special tax treatment. There are several requirements that must be met in order for a corporation to make an election to be an S-Corporation. There are limits on the number of shareholders and who can be shareholders. All shareholders must consent to the election of S-Corporation status as well. There are additional requirements and limitations, so if S-Corporation status seems like it might be right for your corporation, check with an attorney who practices business law to see if your corporation qualifies.
In a C-Corporation, the corporation pays income tax on profits of the corporation. If the corporation pays a dividend to the shareholders, this money is taxed again as income to the shareholders. This is the main disadvantage to a regular C-Corporation. It may not be as bad as it sounds, though. If you are working for your corporation you should be paid a salary. This salary is deducted from the income of the corporation before taxes, so it will only be taxed once. Depending on the business, salaries may use up most or all of the profit. As long as the salary is not unreasonably high, the IRS should not challenge it. Fringe benefits for employees such as health insurance may also be deducted by a C-Corporation, but not by an S-Corporation. For a profitable and growing company it may be better to be a C-Corporation. In a C-Corporation profits beyond salaries and other deductible expenses can be used by the company for growth rather than being distributed to the shareholders and creating taxable income for them.
An S-Corporation does not have the double level of taxation, corporate and individual, that a C-Corporation has. Instead, profits and losses are distributed among shareholders who report that income or loss on their own federal income taxes. This is the main advantage to electing S-Corporation status. It can be particularly advantageous if the shareholders are in a relatively low tax bracket. Or if the business is likely to show a loss at first, the shareholders can use the loss to offset income from other sources. However, if the business is profitable and you want to reinvest the profits, you will pay taxes as the profits are earned in an S-Corporation, rather than when you actually receive the money. This creates an extra tax burden when the profit is earned.
For further information or to discuss your business and corporate law issues, we invite you to schedule a free confidential consultation with an experienced northern and southern California business law attorneys by calling us at 916.983.2941, or filling out our contact us form on our website. The confidential consultation is free.
A traditional corporation, known as a C-corporation, is taxed as a separate entity, leading to double taxation of corporate income and dividends to shareholders. An S-corporation, on the other hand, is a corporation that elects to be treated as a pass-through entity (such as a sole proprietorship or partnership) for tax purposes. Since all corporate income is "passed through" directly to the shareholders who include the income on their individual tax returns, S-corporations are not subject to double taxation. Moreover, the accounting for an S-corporation is generally easier than for a C-corporation. There are, however, certain restrictions placed on S-corporations:
- The S-corporation must not have more than 100 stockholders, and each of them must consent. (A married couple is treated as one stockholder).
- Each stockholder must be an individual who is a citizen or resident of the United States, or an estate or qualifying trust of such person.
- The corporation must have only one class of stock. (However, voting differences within a class of stock are permissible). Preferred stock is not allowed.
- The corporation must use the calendar year as its fiscal year unless it can demonstrate to the IRS that another fiscal year satisfies a business purpose.
Corporations wishing to become an S-corporation must file a Form with the IRS, and each stockholder of the corporation must sign the form.
If the number of shareholders in your corporation is small, you may think that becoming an S-Corporation is the right move, but you should weigh the advantages and disadvantages first.
Advantages of S-Corporation Status
One of the main advantages of S-Corporation status is that it avoids the double taxation that occurs with a regular C-Corporation. In a C-corporation, the corporation pays income tax on its profits and, if those profits are distributed to shareholders, the shareholders pay income tax on the distribution.
Electing S-Corporation status passes the income or losses of the corporation to the shareholders who recognize the income or loss on their personal tax returns. This is an advantage if the corporation expects to show a loss at first. The loss can be used to offset the shareholder's income from other sources, including a spouse's income.
Disadvantages of S-Corporation Status
Passing income through to shareholders can be a disadvantage in some instances. If the business is profitable, shareholders will be required to pay income tax on their share of the profits, even if that money is not distributed to them. In a C-Corporation, profits can be used to expand the business and shareholders are not required to pay taxes until distributions are made.
Reasonable salaries paid to employees are deductible business expenses for S-Corporations as well as for C-corporations. However, in an S-Corporation, fringe benefits may not be deductible as they would be in a C-Corporation.
Even though losses pass through to shareholders in an S-Corporation, those losses aren't deductible by shareholders who don't materially participate in the business. This could result in higher taxes overall.
S-Corporation Requirements
Not every corporation qualifies for S-Corporation status. In order to elect S-Corporation status, the corporation can only have one class of stock. The corporation can have no more than 35 shareholders, although a husband and wife who both own shares will only be counted as one shareholder. No shareholder can be a nonresident alien or another corporation. All of the shareholders must consent to elect S-Corporation status. The corporation also cannot earn too much of income from investments.
If you think an S-Corporation election makes sense for your corporation, see an attorney who practices in the area of business law. The attorney can explain to you how the advantages and disadvantages of S-Corporation status will impact your particular business.
If you're incorporating your small business you may have heard that you should incorporate as an "S-Corporation." Whether this is true or not depends on your situation and what you expect from your business.
An S-Corporation is a corporation that has made an election under subchapter S of the Internal Revenue Code that allows for special tax treatment. There are several requirements that must be met in order for a corporation to make an election to be an S-Corporation. There are limits on the number of shareholders and who can be shareholders. All shareholders must consent to the election of S-Corporation status as well. There are additional requirements and limitations, so if S-Corporation status seems like it might be right for your corporation, check with an attorney who practices business law to see if your corporation qualifies.
In a C-Corporation, the corporation pays income tax on profits of the corporation. If the corporation pays a dividend to the shareholders, this money is taxed again as income to the shareholders. This is the main disadvantage to a regular C-Corporation. It may not be as bad as it sounds, though. If you are working for your corporation you should be paid a salary. This salary is deducted from the income of the corporation before taxes, so it will only be taxed once. Depending on the business, salaries may use up most or all of the profit. As long as the salary is not unreasonably high, the IRS should not challenge it. Fringe benefits for employees such as health insurance may also be deducted by a C-Corporation, but not by an S-Corporation. For a profitable and growing company it may be better to be a C-Corporation. In a C-Corporation profits beyond salaries and other deductible expenses can be used by the company for growth rather than being distributed to the shareholders and creating taxable income for them.
An S-Corporation does not have the double level of taxation, corporate and individual, that a C-Corporation has. Instead, profits and losses are distributed among shareholders who report that income or loss on their own federal income taxes. This is the main advantage to electing S-Corporation status. It can be particularly advantageous if the shareholders are in a relatively low tax bracket. Or if the business is likely to show a loss at first, the shareholders can use the loss to offset income from other sources. However, if the business is profitable and you want to reinvest the profits, you will pay taxes as the profits are earned in an S-Corporation, rather than when you actually receive the money. This creates an extra tax burden when the profit is earned.
For further information or to discuss your business and corporate law issues, we invite you to schedule a free confidential consultation with an experienced northern and southern California business law attorneys by calling us at 916.983.2941, or filling out our contact us form on our website. The confidential consultation is free.