economics

January 28, 2010

S Corp vs C Corp Advantages, Disadvantages

Filed under: Uncategorized — ktetaichinh @ 3:19 am
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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 the 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.

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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.

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