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TAXATION

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S Corp v. C Corp

Briefly discuss the similarities and differences between a S Corp v. a C Corp.

Replies

There are many similarities and differences between S corporations and C corporations. While all corporations start as C corporations, they can be changed to an S corporation. This requires the taxpayer to file IRS form 2553 if they wish to make the change. State tax forms will also be necessary to prepare. There are many other requirements for both that are the same.

Both have directors (shareholders) that run the business. Shareholders get a part of the profit depending on their percentage of shares they hold. The main difference between the two types of corporations is in the way they are taxed. There is a double tax on dividends for C corporations. Profits from C corporations are taxed and are reported on the corporate tax return. These profits are given in the form of dividends. The after tax profits that are distributed as dividends are also taxed. In an S corporation the shareholders report the income on their tax returns and are taxed.

C corporations have greater flexibility when selling, holding, and issuing stock. The IRS has stipulations on S corporations. According to the IRS an S corporation may not have greater than 100 shares of stock, cannot have more than one class of stock, or be owned by any other C corporation, S corporation, LLC, partnership or types of trusts. Also, only U.S citizens or residents may hold stock. The S corporation can’t deduct benefits costs unlike the C corporation which can.

Small businesses like S corporations because of the tax savings and large companies like the flexibility they get from C corporations.

Reference:

https://www.legalzoom.com/articles/what-is-the-difference-between-s-corp-and-c-corp

C corporation is a separate legal entity owned by shareholders and formed by filing incorporation documents with a state and paying fees. A corporation may be right for a person if they:

-want flexible profit-sharing among owners

-want flexibility to set salaries for employees/owners to minimize Social Security and Medicare taxes

-Want to be able to easily sell your business

-Expect your business to own real estate and much more

An S corporation is a standard corporation that elected a special tax status with IRS. It shares the same requirements as a C corporation but it's special tax status eliminates the double-taxation that can occur with a C corporation's income. An S corporation works better if you:

-want flexibility to set salaries for employee/owners to minimize Social Security and Medicare taxes

-Flexibility of accounting methods is desired, because corporations must use the accrual method of accounting unless they are considered to be small corporation and S corporations typically don't have to use the accrual method unless they have inventory.

The big differences between the two include:

-Taxation: Profits of C corporations face possible double taxation when corporate income is distributed to shareholders as dividends. S corporations are pass-through tax entities so there is no tax paid at corporate level

-Corporate ownership: C corporations have unlimited number of shareholders while S corporations can have no more than 100 shareholders.

-S corporation election: must become an S corporation by making a timely filling of Form 2553 with IRS, and all shareholders of the corporation must agree in writing to the S corporation election.

-Michael

Retrieved July 24, 2017 from:

https://www.bizfilings.com/toolkit/research-topics/incorporating-your-business/compare-types-of-businesses

Discussion 2

Permitted Tax Years for Partnerships and S Corporations

Both S Corps and partnerships have rules on permissible tax years, and cannot just use whatever tax year they like. What are the rules for each? Compare and contrast them, since they are not exactly the same. What is the government worried about? In other words, what tax-saving scheme is the government worried might occur if that these requirements are designed to prevent? Do you think there is really so much to worry about?

Replies:

A partnership must typically use the same tax year as the partners who own the majority of the partnership income and capital. If each is different then the partnership must use the tax year of its principal partners with more than 5% interest in the partnership. And if that doesn’t work then the partnership must use the tax year that has the least aggregate deferral of income to the partners. An S Corporation must adopt a calendar year unless the corporation has a business purpose for electing a fiscal year and be approved by the IRS. From what I could read off the IRS website the reason for these accounting period rules is to prevent partners from deferring partnership income by choosing a different tax year for the partnership. I think this is a logical fear for the government since most people attempt to avoid taxes as best as they can.

IRS Publication 538. 2016. Accounting Periods. Retrieved from:

https://www.irs.gov/publications/p538/ar02.html#en_US_201612_publink1000270602

According to the IRS, S Corps pass all liability on to their shareholders. For each individual shareholder, income, losses, deductions, and credits for their share of the corporation are reflected in their person tax returns subject to their marginal tax rate. The benefit is that the same income is not taxed on the corporate level as well as the at the individual level. Not all of the gains are incomes are passes to the shareholders as some are proprietary to the operation on the business itself.

The following conditions must be present to be considered an S Corporation:

Be a domestic corporation
Have only allowable shareholders
May be individuals, certain trusts, and estates and
May not be partnerships, corporations or non-resident alien shareholders
Have no more than 100 shareholders
Have only one class of stock
Not be an ineligible corporation

https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations

A partnership is more involved that an S Corporation in terms of the involvement of the individuals in the partnership. Partners contribute money, property, labor or skill, any losses or gains in the business are divided upon the partners based on their share percentage.

The partnership is required to disclose annually information about income, deductions, gains, and losses from operations. When the partners file their individual tax returns, the combination of the returns collectively should equal the annual information provided for the partnership.

Partners are owners in the company, so they use a Schedule K-1 versus employees that get a W-2 at the end of the tax year.

https://www.irs.gov/businesses/small-businesses-self-employed/partnerships

In regards to the permitted tax year, or Section 444 compliance, S Corps and partnerships can choose to close their tax year by September 30. This could be elected for many reasons, but the biggest one is to bunch together expected deductions or losses into the same 12 month period starting October 1 to lower the tax liability. I do think these adjustments can be abused like all tax credits, deductions, and losses.