Making the Most of C and S Corporations
Both types of corporations give certain tax benefits, including additional deductions. Learn how they differ and why using both may provide you the best of both worlds.
When you’re running a business, you have a few options for creating a business structure, including a sole proprietorship, partnership, corporation, or LLC. Each of these options has its own set of pros and cons related to taxes and liabilities, so factor in where you see the business going and your goals.
Do you imagine the business scaling? Who is involved? What tax benefits are most important for your situation?
Going the corporation route is a smart option for many different organizations. Whether you choose to form an S corporation or a C corporation will depend on factors like tax advantages, the way you pay shareholders, and deductions.
Let’s look at why you would form a corporation in the first place and the differences between S and C corporations.
Why choose a corporate business structure?
S and C corporations provide additional benefits from some other business structures. Incorporating is a good option if you:
- Need to create more investor interest
- Want additional liability protection
- Want to establish more credibility
- Want the business to have an unlimited life
- Want to have a public company eventually
Corporations provide additional protection so that your business has a bit more authority in the market, and you can separate more of the corporation’s liability from your own. For example, in a sole proprietorship, the owner and the business are considered the same legal entity, so you’d be liable for business-related debts.
When you form a corporation, it will automatically be a C corporation unless or until you elect S corporation status. Here’s a deeper dive into the primary tax implications and other benefits of these two structures.
C corporation pros and cons
The biggest disadvantage of a C corporation is the potential double taxation factor. The corporation pays corporate income tax on income, and its shareholders must also pay personal income tax on dividends from the corporation.
However, they can also offer fringe benefit deductions and allow you to avoid the alternative minimum tax (AMT). C corps have a full deduction of benefits like employees’ health insurance, life insurance, and long-term care premiums, and fringe benefits like vehicle costs and public transportation passes are deductible.
Additionally, C corporations can give you lower tax rates. For example, your first $50,000 in taxable income is taxed at 15% instead of the top marginal rate at which S corporations would be taxed (35%).
S corporation pros and cons
A significant benefit of an S corporation is pass-through taxation (as with a partnership), meaning the corporation doesn’t pay federal corporate taxes. Income is passed through to shareholders, who then report it on their personal tax returns and avoid double taxation seen with the C corporation. Shareholders also don’t have to pay self-employment tax on their share of S corporation profits.
Additionally, you could qualify for the pass-through business income deduction of 20% since an S corporation is a pass-through entity. But this only applies to allocations of S corporation profits that are pass-through income, not compensation that the S corporation pays to you.
A disadvantage of an S corporation is that most fringe benefits the corporation gives to employee-shareholders owning more than 2% of the corporation are taxable as compensation.
Why create both a C and S corporation?
When you’re unsure which corporation to form, you can actually take advantage of both. Many owners choose to get the best of both worlds by creating a C corporation and using a pass-through entity such as an S corporation. You just need to set up two entities for different aspects and functions of the business.
For example, you can use the C corporation for administration or marketing and the S corporation for operational costs or non-deductible expenses like client entertainment. You can then take advantage of the additional tax deductions of a C corporation as well as the pass-through taxation benefits from the S corporation, and your assets will be protected.
Working with tax professionals
If you’re weighing the pros and cons of C and S corporations and are unsure how to proceed, work with an experienced tax professional who can review your situation and guide you forward. The experts at Provident CPA and Business Advisors are ready to assist. We help you understand each business structure and its benefits and how you can pay the least amount of tax legally possible.
Contact our team to learn more about how we can help your business succeed.
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