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Corporations are entities separate from the owner-shareholders and exist either as c corporations or as S Corporations (sometimes called subchapter S corporations). Taxation of each is quite different, so they will be discussed separately.
- Corporations
- What are the tax advantages of a C corporation?
- What are the tax disadvantages of a C corporation?
- S Corporations
- What are the tax advantages of an S corporation?
- What are the tax disadvantages of an S corporation?
C Corporations
A c corporation is formed when a corporation is created. If no election to be treated as an S corporation is filed, it will continue to be a C corporation.
A c corporation is a taxable entity and files its own tax return (Form 1120). It pays tax on its net profits each year. Profits remaining after the taxes are paid can be distributed to the shareholders as dividends.
What are the tax advantages of a C corporation?
C corporations are more flexible than S corporations. They can choose a fiscal tax year. They are not limited as numbers or types of shareholders. They can deduct a number of expenses that other entities cannot. For instance, they can deduct contributions to charities. Other entities must pass charitable expenses through to the owners, who then might be able to deduct them.
Traditionally, they had the most options in choosing retirement plans - though the advantage is not as great as it used to be.
C corporations are the entity of choice for most tax free mergers and acquisitions.
What are the tax disadvantages of a c corporation?
A significant disadvantage is double taxation. By the time the shareholders receive their after-tax shares of the profits, there will have been two levels of tax - a tax on the corporation and a tax on the dividends. For this reason, many people choose a different entity - such as an S corporation or a partnership.
Another disadvantage is that liquidation or sale of the corporate assets will also result in double taxation to the shareholders, if there is any taxable gain.
C Corporations are also less flexible than partnerships when it comes to special allocations of profits or expense items.
Losses stay in the corporation and cannot be passed through to the shareholders.
S Corporations
An S corporation is a C corporation that has filed an election to be taxed as a "pass through" entity. This means that instead of being taxed on its income, it passes the income through to the shareholders, who are then taxed on it. An S corporation files Form 1120S (which is a tax return different from that used by a C corporation).
This election is made on Form 2553 and must be filed no later than 60 days after the beginning of the year in which the election is to be effective. For instance, an election for 2001 must have been filed by the 60th day of 2001 (March 1). Once the election is made, it is effective until revoked.
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