$ole Proprietorship ys. C Corporation ys. 5 Corporation ys. LLC

Transcription

1 C Corporation vs S Corporation vs LLC 3/6/12 1:52 PM Iln" 10: 40Ik fur husjnt'ls Use Your 401k To Fund Your Business No Tax Penalty- Free "How To" Guide '''' 1<11 L1.\ in 3 Eas' SIeps (1) Sign Up (2) Fill in Online Form (3) Launch Your New Business Today! ", ~ I,,';. ii' m"' Set l P lin -Corp Online Incorporate in Under 5 Minutes. No Processing Fees. File Today! R.sko! "'lit" ill (,11 IX') I"c" H', I $ole Proprietorship ys. C Corporation ys. 5 Corporation ys. LLC Fonnation Requirements, Costs Personal Liability Administrative Requirements Sole Proprietorship None C Corp S Corp Limited Liability Company (LLC) Must file with state, state specific filing fee required. Unlimited liability. ~hareholders are not typically held liable. Relatively few requirements. Election of board of directors/officers, lannual meetings, and annual report filing requirements. Management Full control. Shareholders elect directors who manage business activities. Term Taxation Terminated when proprietor ceases doing business or upon death. Entity not taxable. Sole proprietor pays taxes. Perpetual: can extend past death or withdrawal of Taxed at corporate rate and possible double taxation: Dividends are taxed at the individual level if distributed to Double Taxation No Yes, taxed at corporate level and then again if distributed to shareholders in the form of dividends. Self Employment Tax Subject to self employment tax. Salary subject to self employment tax. Must file with state, state specific filing fee required. ~hareholders are not typically held liable. Election of board of directors/officers, annual meetings, and annual report filing requirements. Shareholders elect directors who manage business activities. Perpetual: can extend past death or withdrawal of No tax at the entity evel. Income passed through to the No Salary subject to self employment tax, but shareholder distributions are not subject to employment tax. Must file with state, state specific filing fee required. Members are not typically held liable. Relatively few requirements. Members can set up structure as they choose. Perpetual, unless state requires fixed amount of time. No tax at the entity level. Income passed through to members. No Salary subject to self employment tax. Pass Through Tax Yes No Yes Yes Page 1 of 2

2 C Corporation vs 5 Corporation vs LLC Treabnent 50 e wp. s Co'rp LL-C Tax Fonns 1040 ' IRS Form 1120 IRS Form 1120S 1 member: sole proprietor IRS Form Shareholders get K Schedule C for personal tax Partnership: IRS Form 1065, Members returns. get K-1 Transferability of No Shares of stock are Yes, but must Possibly, depending on restrictions Interest easily transferred. observe outlined in the operating agreement. IRS regulations on who can own stock. Capital Raising Individual provides Shares of stock are Shares of stock are May sell interests, but subject to capital. sold to raise capital sold to raise capital. operating agreement (Securities laws Limitations prevent S (Securities laws may also apply). apply). Icorp stock ownership by corporations. Ease of Operation Easiest Must have annual Must have annual Easy, some states may require more meetings, Board of meetings, Board of than others. Directors meetings, Directors meetings, corporate minutes, corporate minutes, and stockholder and stockholder meetinqs. meetinqs. IFor many small business owners choosing a C corp, S Corp, or Limited Liability Company (LLC) is the first step in incorporating. The above entity comparison table was designed as a helpful reference and is not intended as tax or legal advise. We do not provide tax or legal advice. If you feel like you may need tax or legal advice it's recommended that you contact an at/omey or CPA. Related: Incorporating Ineorone-dle in California Need to Incorporate? Form an LLC, C or S-Corp. Free corp name check!,,"» dllc<i'!l<q!j)!1!j1,nq Legal Fonns File' our B {"orporation Simple secure B corporation filing online. Be on your way in minutes!.,,,,,1, rlj""!ij",t1" 'h\m Tax Tables California \on Profit SOlc3 Filing Service Company Form 1023, By-Laws, Budget, More fllt'''i'' """ Business Plan Bysiness Structure Bysiness Types 3/6/12 1:52 PM All information herein has been prepared soiely for informational purposes, and it is not an offer to buy or sell J or a sofidtation of an offer to buy or sell any secun"ty or Instrument or 10 participate in any particular trading strategy. The Money Alert does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third patty, whether linked to this web site or incijrporated herein, and takes no responsibility. All such information is provided solely for convenience purposes only. The Money Alert is not afflwated with any of lhe Wrms or en/itjes hsted unless speciwcalfy stated. The Money Alert does nol provide investment, tax or legal advice. Please consult the appropn"ate professional regarding your personal situation. Copyright C> 2010 The Money Alert.com. All rights reserved. Page 2 of 2

3 5 Corporation vs. C Corporation I Forming a Corporation 3/6/12 1:55 PM S Corporation vs. C Corporation: A Comparison Category: Incorporating Your Business When starting a business or changing your business structure, one of the most common options small business owners evaluate is whether to form an 5 corporation (5 corp) or C corporation (C corp). These are the two most common ways to incorporate online, and the choice really depends on your business goals. 5 corporation vs. C corporation: The similarities The C corporation is the standard corporation, while the S corporation has elected a special tax status with the IRS. It gets its name because it is defined in SUbchapter S of the Internal Revenue Code. To elect S corporation status when forming a corporation, Form 2553 must be filed with the IRS and all S corporation guidelines met But C corporations and S corporations share many qualities: Limited liability protection. Both offer limited liability protection, so shareholders (owners) are typically not personally responsible for business debts and liabilities. Separate entities. Both the S corp and C corp are separate legal entities created by a state filing. Filing documents. Formation documents must be filed with the state. These documents, typically called the Articles of Incorporation or Certificate of Incorporation, are the same for both C and S corporations. Structure. Both have shareholders, directors and officers. Shareholders are the owners of the company and elect the board of directors, who in tum oversee and direct corporation affairs and decision-making but are not responsible for day-to-day operations. The directors elect the officers to manage daily business affairs. Corporate formalities. Both are required to follow the same internal and external corporate formalities and obligations, such as adopting bylaws, issuing stock, holding shareholder and director meetings, filing annual reports, and paying annual fees. 5 corporation vs. C corporation: The differences Despite their many similarities, S corporations and C corporations also have distinct differences. Taxation. Taxation is often considered the most significant difference for small business owners when evaluating S corporations vs. C corporations C corporations. C corps are separately taxable entities. They file a corporate tax return (Form 1120) and Page 1 of 2

4 5 Corporation vs. C Corporation I Forming a Corporation 3/6/12 1:55 PM pay taxes at the corporate level. They also face the possibility of double taxation if corporate income is distributed to business owners as dividends, which are considered personal income. Tax on corporate income is paid first at the corporate level and again at the individual level on dividends. S corporations. 8 corps are pass-through tax entities. They file an informational federal return (Form 11208), but no income tax is paid at the corporate level. The profits/losses of the business are instead "passed-through" the business and reported on the owners' personal tax returns. Any tax due IS paid at the individual level by the owners. Personal Income Taxes. With both types of corporations, personal income tax is due both on any salary drawn from the corporation and from any dividends received from the corporation Corporate ownership. C corporations have no restrictions on ownership. but S corporations do. S corps are restricted to no more than 100 shareholders, and shareholders must be US citizens/residents. S corporations cannot be owned by C corporations, other S corporations, LLCs, partnerships or many trusts. Also, S corporations can have only one class of stock (disregarding voting rights), while C corporations can have multiple classes C corporations therefore provide a little more flexibility when starting a business if you plan to grow, expand the ownership or sell your corporation. Making the S corporation (5 corp) election To become an S corporation, you must file Form 2553 with the IRS. The IRS instructions-which can be a bit tough to follow-require that an election is considered effective in the current tax year only if the Form 2553 is completed and filed: Any time before the 16th day of the 3rd month (for calendar year tax payers, this means it needs to happen by March 15th) Any time during the preceding tax year (however, an election made no later than 2 months and 15 days after the beginning of a tax year that is less than 21,12 months long is treated as timely for that year). Generally, an election made after the 15th day of the 3rd month but before the end of the tax year is effective for the next tax year unless you can show failure to file on time was due to reasonable cause) Keep in mind that some states also require you to file a state-level S corporation election after incorporating your business. For more guidance Oil which structure to choose-s corporation vs. C corporation-try our Incorporation Wizard. For advice regarding your specific situation, contact an attorney or accountant. / s-corporation-vs-c-corporation.aspx Page 2 of 2

5 s vs. C CORPORATIONS {The following information is not intended to replace the services of a professional qualified income tax consultant who can better understand how these issues fit into your par1icular circumstances. Trying to set up and/or operate a corporation of any kind without competent professional guidance is asking for serious trouble.} I continue to hear attorneys and other allegedly knowledgeable authorities recommending the use of Subchapter S corporations, when that ends up costing the clients a lot more in tax dollars. I guess it's time for another refresher on some of the big differences between normal C corporations and S. This is not intended as a claim that one size fits all in regard to business structure. There are times when an S corporation, or its newest corollary, Limited Liability Companies (LLCs) and Limited Liability Partnerships (LLPs), is a good idea. I just think it is wrong to so quickly jump into such an arrangement without evaluating all of the consequences of doing so Tax Brackets With our country's "progressive" tax rate structure, it is very expensive to have too much income on any one tax return For individuals, the nominal rates go from 10% to 35%, with actual effective rates much higher due to the phasing out of so many tax breaks as income increases. With an S corp, all of the corporation's income flows right onto the 1040 returns of the shareholders, pushing them up into higher tax brackets. A C corporation has its own progressive tax rate structure, ranging from 15% on the first $50,000 of net income, to as much as 39%. My philosophy is to look at the overall tax picture for individuals and their companies by smoothing income over the personal (1040) and corporate (1120) tax returns. For 2012, a married couple's 15% tax bracket ends at $70,700 of taxable income. It then jumps to 25%, almost double the rate. However, if you consider that the couple's C corporation has its own $50,000 15% bracket, their overall combined 15% bracket has more than doubled to $120,700. That alone can save several thousands of dollars per year in income taxes. Income Taxed With an S corp, the shareholders are required to pay income tax on their share of the corporation's income whether they take any money out of the corporate account or leave it in there. A few years ago, I wrote about the consulting client who had to include over $300,000 of S corp income on his 1040, when Page 1 of 4

6 5 Corporations 3/6/12 1:58 PM he had only taken out about $30,000 It wasn't bad enough that he had to pay more income tax than he had received, but things were much worse. He had a child support arrangement requiring him to pay 29% of his adjusted gross income (AGI) each year. This meant he had to pay 29% of the $300,000 to his ex-wife. I~s not fair and I have never understood why child support is based on the parents' income rather than the actual cost to feed and clothe the kids; but that is how things are. If he had shifted all or part of his income into a C corporation, his child support would have been much less expensive. More Deductions As I have described elsewhere, the Section 179 expensing election is much more lucrative for owners of C corporations because they can literally multiply their total deduction by splitting their purchases of business assets among their different business entities (1040 Sale Proplietorships vs Corporations). With an S corp, the Section 179 deduction is limited to just the one amount. Likewise, the deduction for net rental losses is magnified by using a C corp because it can use rental losses to offset all operating income. An S corp's rental losses are subject to the restlictive passive loss rules. Attack On the Rich As I have described on many occasions, "Mean Testing" (penalizing the evil rich) is a growing trend in this country, and is most often measured by the AGI on your People over certain thresholds lose tax breaks and have to pay in more taxes and penalties than others do. Income from an S corp will just make thmgs worse. Income on a C corp will not be counted in most mean testing. Fiscal Year One of the most useful tools in the tax game arsenal is the ability to shift income between taxable years Individuals report their taxable income based on the January 1 to December 31 calendar year. S corporations are required to also use the calendar fiscal year, allowing no opportunity to shift income between years. C corporations, however, can end their fiscal year at the end of any month The first tax return will almost always be less than a full 12 months, so don't worry about coordinating it with the incorporation date. How this saves on taxes is pretty straight forward. Toward the end of your personal fiscal year (12/31), you bleed off some of your taxable income to your C corp by paying it for something like rent or marketing services. In January your corporation can pay it back to you. Near the end of the corp's fiscal year, bleed its net profits out by paying yourself This back and forth income shifting can go on for a long time. Sometimes income is never taxed; or if it is, we make sure that it is taxed at the lowest rate possible (15%). Employee Benefits One of the benefits of a corporation is having it provide lucrative employee benefits that are deductible by the corp and tax free to the employees Medical, life insurance, education, childcare, and retirement plans are just a few of the types of benefits available. I don't have space here to go over the rules for each type of plan. However, on a side by side comparison. the tax free status of some of these plans is much less generous for people owning more than 2% of S corporation stock. For a side by side comparison of the availability of tax free fringe benefits, check out this chart from the Small Business QuickFinder. Page 2 of 4

7 Double Taxation The biggest fear of c-corporations has to do with double taxation, where after-tax earnings are distributed to shareholders as non-deductible dividends. This is rarely a problem with small corporations because there are plenty of ways to pull money out of the corp in a manner that is deductible, and thus only taxed once, Compensation - wages or consulting income Interest Payments Lease Payments Royalty Payments Contributions to Retirement Accounts Remedying A Bad Situation If you have an S corp that is hurting you more than it is helping you, how should you fix it? While this is something you definitely need to work on with your own tax advisor. I can give some general advice First, I have seen a lot of people confused as to whether they even have an S corp or not. When you charter a corporation with your state, it is a normal C corporation. Until you file its first income tax return, the fiscal year is still changeable even if you said something else on the SS-4 form you filed with IRS to obtain an identification number. You have to take the formal step of filing Form 2553 with IRS, signed by all of the shareholders, in order to become an S corporation, Now, if you are an S-corporation, can you convert it to a C corporation? You can by filing a formal request with IRS, that carries the requirement that you cannot change back to an S corporation for at least five years. You will however be stuck with the December 31 fiscal year, nullifying any ability to use the income shifting tax saving strategy. IRS will not allow you to change your fiscal year because they know that will save you money and that is contrary to their purpose in life. What I have found is that it is much easier to just set up a brand new virgin corporation, especially in states like Arkansas and Missouri where it only costs $50 in filing fees. In states like California, where the filing fees are in the thousands, this strategy is a bit more expensive and needs to be evaluated a little more closely, Addendum Lately, I have been receiving a lot of feedback from various people around the country who have read this article, thanking me for pointing out things that other advisors have been ignorant of. One area of confusion still seems to be regarding exactly when a corporation becomes an S. Many people believe that the decision to be an S or a C is made at the time when the corporation is originally formed. That is not true. All corporations, when originally chartered by the State, are C corporations. Do nothing extra and it will remain a C corp. However, to convert it to an S corporation, the shareholders must all sign and submit Form 2553 with the IRS to request that status. This can be done right away after the corp is originally chartered, or several years down the road. You need to be sure to watch the effective dates of the S election, Some States automatically accept the IRS's S election, while others require a separate form to be submitted to the State tax agency, If a corp has been using a fiscal year that ends in a month other than December, it will have to change to a 12/31 fiscal year end if it changes to an S status If the S status is later revoked, you will not be allowed to change from the 12/31 year end, http) /taxguru.org/corps/scarp. htm Page 3 of 4