S Corp vs C Corp

S Corp vs C Corp

S Corp vs C Corp, Advantages, Disadvantages

S Corp vs C Corp If you plan to remove significant profits above what would be considered a reasonable salary for you as President or CEO, you would favor an S corp, because S corp are pass-through tax devices. For S corp, there is generally no tax at the corporate level. This means that once a reasonable wage is paid, excess profits can be removed as distributions. If you chose a C corp, dividends will be doubly-taxed.

S Corp vs C Corp

If the expected profit you remove is comparable to a reasonable wage, you might be OK with either a C Corp or an S Corp.

Wages greatly in excess of reasonable salaries may be challenged by the IRS, who may view the wages as dividends in disguise.Salary is subject to about a 15% self employment, but you do get more future Social Security benefit by paying more in employment tax. And, many retirement plan maximums are also based upon salary level. This somewhat offsets the negative of paying higher employment taxes. Many individuals choose S corp over LLCs, C corps, Sole-Proprietorship, and partnerships to minimize employment taxes on wages. For many individuals. If you plan to remove large amounts of cash from a profitable company and you feel the amounts are larger than a reasonable wage, consider the S Corp.

Retaining Income

If you plan to retain most of the income for corporate growth, either S Corps and C Corps can work well. A C corporation is probably preferable if you plan to offer employee stock options, which could be classified as a second class of stock. S corp shareholders can also face phantom income, but that is easily remedied by paying small distributions to shareholders to offset individual tax liability.

This is the same basic "pass-through" treatment afforded partnerships and LLCs. The key distinction of the S Corp is that profits and losses are not taxed at the corporate/business level like they would be if the corporation remained as a C Corp.

Losses Pass Through

If you have high-income investors, and you anticipate losing money for the first few years an S corp losses pass through to the investors who can offset their other taxable income. This is fully allowed. The IRS is not enthused on tax shelters where losses exceeding an investor's original investment in a company are passed through, as some tax schemes in the past tried to achieve. If such losses in excess of original investment "basis" were allowed, an investor could offset tax deductions. That is not allowed. This is why entrepreneurs need a basic understanding of stock basis and passive losses.

Non People Shareholders

If you have certain non-people shareholders, such as certain trusts, the IRS forbids to own S corp shares. Or, there may be too many shareholders as allowed for S-corp status. To qualify, generally, the corporation must have a maximum of 75 shareholders who are individuals. Once a corporation makes the Subchapter S election to be an S Corp, profits and losses are passed through the corporation and are reported on the individual tax returns of the respective shareholders of the S Corp.

Most corporations have annual revenues of less than $5 million per year. And, many corporate owners remove substantial profits from their companies. For these companies, the S corp structure works well.

S Corp vs C Corp - Similarities

  • Both offer the same limited liability protection for shareholders (owners), meaning that the shareholders are typically not personally responsible for the debts and liabilities of the business.
  • Both are separate legal entities created by a state filing.
  • The formation documents that are filed with the state, which are typically called the articles of incorporation or certificate of incorporation, are the same whether the business will be a C or an S corporation.
  • Corporations have shareholders, directors and officers. Shareholders are the owners of the company and elect the board of directors. The board of directors oversees and directs the affairs of the corporation and has responsibility for major decisions, but is not responsible for the day-to-day operations of the corporation. The directors elect officers to manage the daily affairs of the business. Most states allow one person be a shareholder, director and officer of a corporation.
  • Both are required to follow the same internal and external corporate formalities. Examples of internal formalities include adopting bylaws, issuing stock, holding initial and then annual meetings of shareholders and directors, and keeping the minutes from these meetings with the corporate records. Examples of external requirements include filing annual reports, which are required by the state, and paying the necessary annual fees.
| S Corp vs C Corp

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