by Pat Hill
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.
- Alternative Forms of Incorporation Not every corporation is a C-Corporation or an S-Corporation.
- Checklist for New Corporations Incorporating is just one step in starting a new business.
- Choosing Between Corporation and Limited Liability Company LLCs allow a business to have the limited personal liability of a corporation as provided by state law, while being treated as a partnership for purposes of Federal tax laws.
- Conducting Your Business as A Corporation The limited personal liability of a corporation isn't iron clad.
- Corporations compared to LLCs Limited liability companies are a relatively new type of business entity that combine the personal liability protection of a corporation with the tax benefits and simplicity of a partnership. However, there are still other important differences.
- Corporations Compared to Sole Proprietorships and Partnerships Corporations enjoy many advantages over partnerships and sole proprietorships. But there are also disadvantages.
- Forming A Corporation: The Basics This article outlines what steps you'll need to take to form a corporation.
- Forming a Corporation The life of a corporation begins upon the filing of articles of incorporation with the secretary of state's office.
- Operating a Corporation The most important thing to know about operating a corporation is to leave a paper trail of the important business activities.
- The Pros & Cons of S-Corporation Status 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.
- S Corporations An S-corporation is a corporation that elects to be treated as a pass-through entity (such as a sole proprietorship or partnership) for tax purposes.
- S-Corporation or C-Corporation - Which Should You Choose? Each has different advantages and requirements. Find out more.
- What is a corporation? A corporation is a separate and distinct legal entity.
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