When determining the structure for your business, the consideration of tax implications is a crucial factor, alongside personal liability protection, record-keeping, and financial planning. Your choice of entity not only influences the taxation rate and filing requirements but also impacts various aspects of both your personal and business life.
In the previous installment, we explored the tax obligations related to Sole Proprietorships, Partnerships, and Limited Liability Companies (LLCs). In this continuation, we will delve into the tax treatment of the remaining two entity structures—C Corporations and S Corporations—shedding light on the advantages and drawbacks associated with each.
C Corporations
A C Corporation stands as an independent tax-paying entity, filing its own tax return (Form 1120) to report income, claim deductions, and credits. Currently, C Corporations are taxed at a flat rate of 21% on net income. Post-tax profits are then distributed to shareholders as dividends, subject to personal income tax. This structure involves a system of “double taxation,” where the corporation and the shareholder are taxed separately. To mitigate this, an owner may opt for the C Corporation to be taxed as an S Corporation, as discussed next.
Due to the complexities and costs of managing a traditional corporation and dealing with double taxation, small businesses rarely choose C Corporation status. However, as profits exceed a certain threshold, typically $200,000 annually, considering a C Corporation may become viable. For tailored advice on whether this structure suits your business, consult with us, your Family Wealth and Estate Attorney with business planning expertise.
S Corporations
Unlike an independent business entity, an S Corporation is a tax election made by the owner of a C Corporation or an LLC, indicating that the corporation should be taxed as a pass-through entity. As previously discussed, unless an LLC elects S Corporation status, it is automatically taxed based on its structure.
By electing S Corporation status, all profits are passed through to shareholders, who report their share of profits as income on personal tax returns via a K-1 form. However, not all LLCs or C Corporations can make this election. Specific criteria, such as being a U.S. corporation, maintaining one class of stock, and having 100 shareholders or fewer, must be met. Furthermore, shareholders must be individuals, estates, or certain qualified trusts, and they must consent in writing to the S Corporation election.
For this election to yield tax benefits, the business should have at least $60,000 of net income annually. It’s essential to discuss the matter of “reasonable compensation” with your Family Wealth and Estate Attorney and CPA to ensure compliance with IRS requirements. Failure to do so may lead to severe consequences, such as reclassification of distributions as wage payments, resulting in back taxes, penalties, and potential negligence charges.
Selecting the Right Tax Treatment
Choosing the appropriate entity structure involves navigating complexities, and it’s not an endeavor to tackle alone. As your Family Wealth and Estate Attorney with business planning expertise, we provide trusted advice on selecting the most suitable entity for your business, considering not only tax implications but all relevant factors. From personal liability protection to administrative requirements and financial considerations, we offer the support and guidance needed for optimal decision-making. Reach out to us today for comprehensive assistance tailored to your business needs.
This article is presented by Michelle Bell, an expert in estate planning and business succession services. Our office provides comprehensive legal support for businesses, assisting you in making informed decisions throughout your entrepreneurial journey and in planning for future contingencies. We also offer a specialized session where we review your business’s legal structures. To arrange this consultation, please click the following link: https://calendly.com/mcblawpllc/30min.
The information in this article is intended purely for educational and informational use and should not be considered as advice on ERISA, tax, legal, or investment matters. For advice specifically tailored to your unique situation, such advice should be sought independently from this educational content.