Tax Aspects of S Corporations

An 'S' Corporation is a small business that has filed a Form 2553 with the U.S. Internal Revenue Service. The Form 2553 is an official corporate document representing a 100% shareholder approval of the desire to become recognized as an 'S' Corporation as governed by Section 1362 of the U.S. tax code Title 26 . Both new and pre-existing companies regulated by different tax statutes may become S corporations provided they meet the requirements.

Qualification to become an S Corporation

Form 2553 must be filed before March 15 of a given year to qualify as an S corporation for that year.
To Form a S corporation, there may only be 99 or less owners/shareholders. The Shareholders must also be legal U.S. residents. If an existing company is filing the Form 2553, that company may not be a 'C' Corporation i.e. a more formal business subject to different tax regulations.

Tax benefits and taxation of S Corporation:

S Corporations are able to avoid what is known as 'double taxation'. Double taxation is when profits a company earns are taxed, and then the profits distributed to the owners are taxed again on their individual tax forms. S corporations avoid this by not always having to pay tax on earnings. Instead, as with Limited Liability Corporations, those earnings or losses are either added to or deducted to the shareholder's personal income.

Another tax benefit of S corporations is the ability of the corporation to pay dividends. Dividends are profits that are passed on from companies to shareholders. Since dividends are not taxed the same way as employee income, S corporations can avoid paying extra federal employment taxation, thus saving money.

IRS tax forms for S Corporations:

The tax forms required of S corporations by the Internal Revenue Service include the following. These requirements can be viewed at the Internal Revenue Service website.

Form 1120S: The company's tax documentation form
Form 941 or 943: Employment taxes withholdings
Form 940: Additional employment withholdings such as social security, Medicare etc.
Form 1040: Individual Tax documentation for shareholders

TIPS on Becoming an S Corporation:

Check State laws regarding S Corporations, as they may not recognize S corporations the same way the Federal Government does, thereby excluding them from the same taxation rules applied at the Federal level.

Paralegal services may be all that is needed to set up an S corporation if a company does not do so independently. Tax accountants and/or attorneys specializing in taxation law may also be of assistance in certain situations.

According to Title 26, Code 1362 of the U.S. tax code, an S corporation is no longer a S corporation if the company no longer meets the requirements of a S corporation or if the company earns a specific amount of income after 3 years i.e. more than 25% of total revenue over 3 years.

Forecasting your corporations growth, needs, size and capitalization requirements may be useful when determining if an S corporation is the right classification for your business. This may be beneficial as if the company outgrows itself, it may have to change its tax status causing added complications in the future.

If a company pays out all its earnings as dividends, it may not have to withhold income tax if there are no salaried employees, thereby avoiding double taxation. This would make formation as an S corporation not as attractive if it is formed entirely on the premise of avoiding double taxation.

Deciding whether or not to form an S corporation or switch to an S corporation from an LLC or sole proprietorship may not be a decision one makes in a couple of minutes over a coffee. There are several aspects of earnings distribution, taxation code, number of employees and corporate forecasting that may all impact the benefits of such a decision. S corporations are generally have less responsibility in terms of IRS regulations than do C corporations. In spite of this, C corporations may have its unique advantages over an S corporation such as charitable contributions tax deductions exclusive to the C corporation.

How a C Corporation is taxed

C corporations are the largest of U.S. corporations and also subject to the most extensive tax reporting requirements and documentation. C corporations may include a private company with 200 shareholders or a large publicly traded company with market capitalization in the billions of dollars. C corporations are subject to reporting a lot of financial activities and thus require strong bookkeeping and documentation throughout the tax year.

Tax forms required

There is a considerable amount of required documentation for filing as a C corporations. The primary IRS form is the 1120 which is different from the 1120S, a tax form required for S-Corporations which are small businesses with 100 or less shareholders. The form 1120 also includes several schedules that are used for calculating cost of goods sold, tax credit, total officer compensation, balance sheet items and dividends. The necessary documents to fill out and their complete instructions are freely available through the Internal Revenue Service.

How tax is calculated for C corporations

A primary factor in the calculation of how much a corporation will be taxed is retained income. The higher the retained income, the higher the tax imposed on the corporation will be. Since retained income is the bottom line after expenses and costs have been deducted this number can end up being quite a bit lower than revenue from sales and sometimes even negative in which case no tax is applied.

The idea that a C corporation is subject to double taxation is theoretically true but in cases where the shareholders do not sell their shares of the company they are not taxed capital gains tax. In other words, capital gains taxes are only charged following sales of shares and dividends are both deductible from taxation before earnings and taxed a lower rate than capital gains to shareholders.

C corporation tax lowering strategies

There are several ways to lower the tax of a C corporation. Specifically, since state taxation is also a factor, choosing to headquarter and/or operate a C corporation out of state with favorable business laws can be advantageous. For example, operating out of Nevada can be beneficial for a C Corporation because there are no state taxes or franchise fees imposed on the businesses. For C corporations that don't mind operating out of the U.S. mainland, the territory of Puerto Rico also offers significant tax advantages.

Additional strategies include the paying out of dividends or redirecting profits into a dividend reinvestment program (DRIP), profit sharing plans and./or pensions, both of which are tax deferred to participants and tax deductible to the corporation. Other options can include forming a different corporation altogether, for example a non-profit corporation or a MREIT in the case of real estate investment companies. The latter of these pays no taxes because the profits are either reinvested into the company or distributed among shareholders in the form of deductible dividends.

Another interest tax fact about C corporations is that in tax years where the company experiences a net loss, not only does the company not pay taxes, but the loss can be carried over to the following year and deducted from the total earnings of that year or any other year up to 5 years after the year of the loss. This is an incentive to assist struggling C corporations or C corporations in financial readjustment regain profitability without tax burden.

Summary

C corporations are one of several types of businesses identified within the United States tax code. C corporations are the largest type of corporation and subject to the highest amount of tax reporting requirements. However, C corporations are also able to deduct significantly more from revenue numbers than smaller corporations and the double taxation often associated with C corporations can be avoided with drips, long term holding of shares, and various other tax strategies including but not limited to net loss carry over from previous years, state or territory of operation and profit sharing plans.

Sources:

1. http://www.irs.gov
2. http://www.expertlaw.com/library/business/c_corporation.html

Tax Aspects of LLCs

A Limited Liability Corporation (LLC) is a company formed under legal protection from personal liability of the owner(s)/member(s). This means if the company should fall into financial difficulty the debts of the company cannot be paid from the owner's personal assets.

Limited Liability Corporations generally have lower tax filing requirements, and Government associated regulation that would be the case with larger more complex corporations.

Taxation of Limited Liability Corporations is accorded its own specific rules and regulations, some of which are made available through the Internal Revenue Service. Income or losses from LLC's are either taxed on form 1040's as individual income if only one owner/member exists, and on a form 1065 as capital gains or losses if more than one member owns the company.

Furthermore, in the case of a LLC with multiple members, the tax benefits are the same but the tax paperwork requirements are different. The taxation of short term capital gains is subject to the same tax bracket as an individuals regular income bracket i.e. gains incurred within a time period of under a year fall into the tax filers adjusted gross income tax range.

The IRS tax forms needed for Limited Liability Corporations include any one of the following depending on the type of LLC, and are available through the Inernal Revenue Website www.irs.gov and/or through contact with the I.R.S.

• Forms1120, or 1120S, and sometimes 8832 if filing as a corporation.

• 1065 if filing as one of a group of members/owners

• Schedule C , E or F if an individual owner of a LLC

• W-2's (Employees)

Tax advantages of LLC's:

If a Limited Liability Corporation has only one member, the member remains legally free from the company's liability, and may file a company's income and expenses associated with his or her personal tax disclosures.

The benefit this allows is single taxation of earnings rather than double taxation through both the owner of the LLC and the LLC itself. Additionally, income earned through the LLC can be withdrawn as a dividend or profit distribution without concern of taxation through the LLC.

When filing as a partnership, LLC's can deduct bad debt, property depreciation, tax, salaries, interest expenses and employee benefit programs on IRS form 1065.

LLC's may be subject to tax exemptions

If a Limited Liability Corporation qualifies for tax exemptions, the benefits of these exemptions is passed on to the owners through a higher income that is only taxed once. For example, a LLC may be exempt from property tax in various jurisdictions making the net profit of that LLC higher due to lower operating costs. This profit is then passed on to owners.

Other tax deductions include losses incurred through the LLC. Thus even though the owner's personal assets are not at stake, the benefits of a failing or company experiencing losses can still be maximized upon as capital loss deduction on IRS Form1040.

TIPS on LLC taxation

• LLC's may be suitable for small startup companies or companies that do not require a large amount of capitalization to operate.

• Forming an LLC may be right for you and/or your business partners if you want to protect your 

personal assets and avoid double taxation.

• As a business owner, or as a partnership LLC, administrating tax reporting requirements may be more simple and easy to operate as an LLC.

• If switching an existing company into an LLC be aware that the valuation the LLC may be considered higher by the IRS, thus incurring a potentially unwanted capital gain.

• Tax accountants and lawyers may also be of assistance when forming and LLC or preparing LLC tax documents.

There are many advantages to Limited Liability Corporations including convenience, simpler taxation, avoidance of double taxation and of course limited liability. Considering formation as a LLC may involve state regulations that vary across one's nation. 

That is to say, incorporation requirements may vary from state to state thus presenting particular advantages and/or disadvantages to incorporation in one state over another. It may be advisable to consider these incorporation guidelines prior to incorporation as an LLC in regards to potential forms of lower taxation, ease of operations, administrative regulations and operating limitations.

How a C Corporation is taxed

C corporations are the largest of U.S. corporations and also subject to the most extensive tax reporting requirements and documentation. C corporations may include a private company with 200 shareholders or a large publicly traded company with market capitalization in the billions of dollars. C corporations are subject to reporting a lot of financial activities and thus require strong bookkeeping and documentation throughout the tax year.

Tax forms required

There is a considerable amount of required documentation for filing as a C corporations. The primary IRS form is the 1120 which is different from the 1120S, a tax form required for S-Corporations which are small businesses with 100 or less shareholders. The form 1120 also includes several schedules that are used for calculating cost of goods sold, tax credit, total officer compensation, balance sheet items and dividends. The necessary documents to fill out and their complete instructions are freely available through the Internal Revenue Service.

How tax is calculated for C corporations

A primary factor in the calculation of how much a corporation will be taxed is retained income. The higher the retained income, the higher the tax imposed on the corporation will be. Since retained income is the bottom line after expenses and costs have been deducted this number can end up being quite a bit lower than revenue from sales and sometimes even negative in which case no tax is applied.

The idea that a C corporation is subject to double taxation is theoretically true but in cases where the shareholders do not sell their shares of the company they are not taxed capital gains tax. In other words, capital gains taxes are only charged following sales of shares and dividends are both deductible from taxation before earnings and taxed a lower rate than capital gains to shareholders.

C corporation tax lowering strategies

There are several ways to lower the tax of a C corporation. Specifically, since state taxation is also a factor, choosing to headquarter and/or operate a C corporation out of state with favorable business laws can be advantageous. For example, operating out of Nevada can be beneficial for a C Corporation because there are no state taxes or franchise fees imposed on the businesses. For C corporations that don't mind operating out of the U.S. mainland, the territory of Puerto Rico also offers significant tax advantages.

Additional strategies include the paying out of dividends or redirecting profits into a dividend reinvestment program (DRIP), profit sharing plans and./or pensions, both of which are tax deferred to participants and tax deductible to the corporation. Other options can include forming a different corporation altogether, for example a non-profit corporation or a MREIT in the case of real estate investment companies. The latter of these pays no taxes because the profits are either reinvested into the company or distributed among shareholders in the form of deductible dividends.

Another interest tax fact about C corporations is that in tax years where the company experiences a net loss, not only does the company not pay taxes, but the loss can be carried over to the following year and deducted from the total earnings of that year or any other year up to 5 years after the year of the loss. This is an incentive to assist struggling C corporations or C corporations in financial readjustment regain profitability without tax burden.

Summary

C corporations are one of several types of businesses identified within the United States tax code. C corporations are the largest type of corporation and subject to the highest amount of tax reporting requirements. However, C corporations are also able to deduct significantly more from revenue numbers than smaller corporations and the double taxation often associated with C corporations can be avoided with drips, long term holding of shares, and various other tax strategies including but not limited to net loss carry over from previous years, state or territory of operation and profit sharing plans.

Sources:

1. http://www.irs.gov
2. http://www.expertlaw.com/library/business/c_corporation.html