To be an S Corporation or not to be an S Corporation that is the question:
You have formed a new corporation and you are wondering if you should make an S Election to treat the newly formed corporation as a small business corporation pursuant to subsection “S” of the tax code. This article will go over a couple of the pros and cons of the S versus the C corporation.
The main reason someone would elect S status for their corporation is to obtain pass-through taxation. This is one of the biggest draws to forming an S Corporation because it keeps double taxation at bay. It is also the primary factor that differentiates S Corporation from C Corporation. Plenty of businesses incorporate as S corporations, especially franchises since the entity allows you to save money on FICA payroll taxes. However, there are rules governing the monies taken out of a S Corporation by stockholders that must be adhered by. Briefly, if monies are taken by a stockholder of an S Corporation some of the monies will need to be classified as payroll and subject to payroll taxes. These rules deal with the reasonable compensation required of stockholders of S Corporation.
- There are a number of limitations to being able to elect S status as listed below.
- The corporation must be based out of the United States and file as a US Corporation.
- The corporation must maintain a maximum of 100 shareholders. These shareholders must have a U.S. Social Security Number and consent in writing to the S Corporation election.
- Only one class of stock may be issued.
If you meet these qualification, you may elect S corporation status by filing the appropriate election form and filing an annual 1120S US Income Tax Return for an S Corporation.
Moving forward as a C Corporation is a much more traditional route that comes with different tax treatments. Any gains or profits made by the business are distributed to the shareholders to be taxed twice, either through dividends or payroll. C corporations are unable to pass losses through to their shareholders, but they can apply the tax benefit of a loss to future profits within the C corporation in order to reduce the entities tax burdens. Good for the business, but a drawback to any shareholder who wanted the ability to write off expected losses.
Some of the benefits of operating as a C Corporation are:
- Allowed to go public
- The current tax rate of the C Corporation is quite low and if monies are not taken from the entity could afford a tax savings
- Can have an unlimited amount of stockholders
- Can raise investment capital•Can write off benefits like health insurance and dental plans as business expenses.
If the C corporation route is what you choose you will file your annual return via Form 1120 U.S. Corporation income Tax Return. While an S Corporation has strict rules against nonresident alien shareholders, C Corporation might just be the perfect entity choice for immigrant-owned businesses.
This has been a very cursory look at the choice between these two entities. Feel free to contact me if you would like to explore these options in much greater detail.