Taxation for a C Corporation Vs. an S Corporation

By Terry Walcott

A corporation is a creature of statute that has a legal identity separate from its owners, known as shareholders, and offers them limited liability. Corporations are formed by filing articles of incorporation with the Secretary of State, or equivalent regulatory office, of their state. Maintenance of corporations requires certain formalities, such as the adoption of bylaws, board of directors, board meetings and minutes, and the filing of tax returns. For purposes of federal taxation, corporations may be taxed under the Internal Revenue Code as either a Subchapter C corporation or Subchapter S corporation.

C Corporations

C corporations are required to pay federal taxes and file annual corporate tax returns using Form 1120. Current federal tax rates range from 15 to 39 percent of taxable income; any remaining after-tax corporate profits can be kept by the corporation as retained earnings or paid out to shareholders as dividends. In the case of dividend payouts, corporate shareholders are required to pay individual taxes on such income. In this way, C corporations are subjected to double taxation—profits are taxed once at the corporate level and a second time at the individual level, after distribution as dividends.

S Corporations

An S corporation is another form of corporation; it has the same basic organizational structure as a C corporation. The Internal Revenue Code sets out certain requirements for S corporation status: (1) corporation must have 100 or fewer shareholders; (2) shareholders can only be individuals, estates or certain trusts; (3) nonresident aliens cannot be shareholders; (4) there can only be one class of stock; and (5) the election to be treated as an S corporation must be made by filing Form 2553 with the Internal Revenue Service within two-and-one-half months of the date of incorporation.

Ready to incorporate your business? Get Started Now

Advantages of S Corporations

One of the major advantages of an S corporation over a C corporation is that S corporations are generally not subject to double taxation. An S corporation does not pay corporate income taxes, except for certain capital gains and passive income taxes. Instead, the profits of an S corporation pass through to its shareholders and are taxed as individual income. Another major advantage of an S corporation over a C corporation is that business losses are also passed through to shareholders and therefore, can be deducted from individual income—which is not the case with C corporations.

State Taxes

The election of S corporation status only applies to federal taxes not state taxes. In fact, the states of California and Illinois tax S corporation profits, albeit at lower rates than C corporations; and the District of Columbia does not recognize S corporation status at all.

S Corporation, LLC or Partnership?

S corporations are generally a good choice for small businesses that want to use the corporate form and avoid the double taxation problem of C corporations. It should be noted, however, that there are other company forms, such as partnerships and limited liability companies, that offer the same “pass through” tax benefits of S corporations without having to incur the significant cost of maintenance (paperwork and formalities) associated with an S corporation. So persons considering an S corporation should investigate a partnership or LLC before making a final decision.

Ready to incorporate your business? Get Started Now
Comparison of LLC to S Corporations in Maryland
 

References

Related articles

What Are the Benefits of a S Corp Vs. an LLC?

Minimizing tax obligations and limiting legal liability are among the most important factors to consider in choosing a legal structure for your business. Depending on your particular circumstances, either an "S corporation" or a limited liability company, also called an LLC, may provide the most advantageous structure for your business.

Advantages of LLC vs. an S-Corporation

A limited liability company (LLC) is a form of business organization authorized by state statutes to accommodate business needs for limited liability, pass-through taxation and operational flexibility. An S corporation is a corporation that enjoys limited liability, as well as pass-through taxation under Subchapter S of the Internal Revenue Code, as long as it meets certain standards. Each type of entity offers certain advantages.

S Corporation Passive Income Restrictions

An S corporation is a corporation consisting of 100 or fewer shareholders that has a special tax designation granted by the IRS. While this designation offers the shareholders certain tax benefits, it requires the company to adhere to several restrictions and conditions. One of these restrictions involves how much passive income the business earns. It is important for an S corporation to closely monitor how much passive income it earns to ensure that it avoids any IRS penalties or tax repercussions.

LLCs, Corporations, Patents, Attorney Help Incorporation

Related articles

Can You Fill Out a 2553 Before the Articles of Incorporation?

A business entity that wishes to become an S corporation must file Form 2553 with the IRS. However, before a business ...

Tax Consequences of Converting a C-Corp to an S-Corp

Corporations are business entities formed under state law that exist separately from their owners. An S corporation is ...

Can a C-Corporation Be a Partner in a Partnership?

Typically, a C corporation is allowed to be a partner in a partnership. However, as is often the case in corporate ...

S-Corp Shareholder Requirements

An S corporation is a business that has made the election to be taxed as a pass-through entity, meaning that each ...

Browse by category
Ready to Begin? GET STARTED