Understanding the Tax Implications of C and S Corporations

If you’re the type of person who loves tax season so much that you don’t care how much money your company pays the IRS each year, go ahead and skip this article—because what you’re about to read is an analysis of the tax differences between C-corps and S-corps. You’ll get insights into how your business structure can take your operations to the next level. And, if the sky’s the limit on your tax bill, these things probably won’t interest you.

If you like to keep as much of your money as possible, though, you’ve come to the right place. Prepare for an enlightening journey into the fascinating world of business entities.

Why a Business Entity?

There comes a time in most entrepreneurs’ lives when it becomes advantageous to stop running a small operation and officially set their business up as an entity. Here are some of the potential reasons to take this step:

• Save on taxes
• Manage your growth
• Qualify for financing
• Enjoy liability protection

Choosing an ideal business structure can provide a major boost to your success. On the other hand, getting stuck with a bad match often results in struggles.

“Of all the decisions you make when starting a business, probably the most important one relating to taxes is the type of legal structure you select for your company,” cautions Entrepreneur. “Not only will this decision have an impact on how much you pay in taxes, but it will affect the amount of paperwork your business is required to do, the personal liability you face, and your ability to raise money.”

If this sounds dire, it’s worth noting that you can usually switch from one entity to another if necessary. The difficulty of the process varies depending on your state’s rules.

Similarities of C-Corps and S-Corps

As you can probably guess from the miniscule difference in their names, C-corps and S-corps have a lot in common. With both structures, the owners are known as shareholders. They elect directors who then assign officers to run the business’s operations. There are bylaws to draft, director meetings to schedule, and official resolutions to distribute.

All these responsibilities make C-corps and S-corps much more complex than lower-stress entities like sole proprietorships or general partnerships. But the detail-oriented nature of these entities provides liability protection for business owners. The government views the business as a separate entity from the owners, so business losses don’t threaten the personal finances of the owners.

The setup process for a C-corp or S-corp is costlier and lengthier than many other business structures, but their advantages can be compelling. 

Crucial Differences on the Tax Front

Some of the distinctions between C-corps and S-corps relate to the number of possible shareholders, regulations on who can be a shareholder, stock-class options, and the deductibility of insurance costs. But let’s focus on the biggest difference: how you handle your taxes.

With a C-corp, you report your taxes up front with a corporation tax return. But there’s a tricky rule that could mean you might be taxed yet again before the government is through with you. If shareholders in your corporation earned profits that were paid out as dividends, those shareholders would be taxed at the personal level.

This double-tax scenario, which isn’t uncommon, can turn some people off to C-corps. It all comes down to whether the unique benefits of C-corps outweigh the tax rules for your unique business.

While C-corps are the most popular form of corporations overall, S-corps are most often chosen by individuals from the small business ranks. A key benefit to this structure: you aren’t taxed with a corporation tax return. This arrangement spares you a lot of time and hassle and can also yield big savings.

Your business profits and losses in an S-corp pass through to individual shareholders’ personal taxes. This means that you only need to handle taxes once each year, and it’s with the simplicity of personal taxes versus the rigamarole that comes with corporate taxes. The savings can also be substantial since you only make a tax payment once.

Other Business Entities to Consider

Perhaps you’re not sure about the best business structure for your business—but rest assured, you have options. Here’s a quick look at 4 other possible entities you could choose:

Partnership (aka General Partnership)

A partnership is a great solution for sharing ownership with other people—as well as the financial liability. That’s right: with a partnership, you don’t get the same protection as you do in a C-corp or S-corp.

Limited Partnership

Just as S-corps are more user-friendly than C-corps, limited partnerships are more flexible than partnerships. You can structure your business in a more customized way, with some partners taking lead roles and others serving as investors. The full partners have liability for the business’s finances, while investors are protected due to their minimized role.

Sole Proprietorship

Inexpensive and easy to establish, sole proprietorships are the most beloved business entity in the nation. This type is exclusively for businesses with only 1 owner. If you own a sole proprietorship, you keep all of your business’s profits—and at the same time, you’re also solely responsible for any debts and losses.

Limited Liability Company (LLC)

This structure is somewhat of a hybrid between corporations and partnerships. You can include unlimited shareholders, which can open up new opportunities. Also, you have complete liability protection.

Decisions, Decisions, Decisions

It can be difficult to nail down which structure is right for your business—that’s why it’s so important for you to consult with a tax professional. They can help you to identify how the various advantages and disadvantages of each entity might affect your business.

In some situations, there’s a clear choice for the best structure. Other times, multiple options could be equally beneficial. What matters: doing your due diligence to make the most informed decision possible.

The information provided in this post does not, and is not intended to, constitute tax advice; instead, all information, content, and materials available in this post are for general informational purposes only. Readers of this post should contact their tax professional to obtain advice with respect to any particular tax matter.