Difference Between C Corp and S Corp for Taxes: Everything You Need to Know
The difference between C Corp and S Corp for taxes is that C-Corps pay corporate taxes but S-Corps do not. 4 min read
2. Federal Tax Differences
The difference between C Corp and S Corp for taxes is that C-Corps pay corporate taxes but S-Corps do not. In addition, C corporations are, in some states, subject to corporate state taxes, which S corporations may not be required to pay.
C-Corps and S-Corps: Similar But Different
Some LLCs and corporations can decide to be taxed as S-Corps if they anticipate getting tax savings when they make the switch. Such businesses inform the IRS of their decision using Form 2553. Choosing entity taxation classification is a major decision which business owners need to go about with care. It is best to involve a professional tax lawyer because the decision will have lasting tax consequences.
The two entities have a few taxation similarities:
- The owners of both entity types pay income tax.
- Both businesses are responsible for withholding and paying payroll taxes for shareholder-employees and other employees.
S corporations and C corporations have a number of taxation differences both on the federal and state levels.
Federal Tax Differences
C corporations are viewed as separate entities by the IRS. They file and pay corporate tax using Form 1120. S-Corps, on the other hand, do not pay corporate tax. Form 1120S filed by S-Corps is solely for information purposes. Using this form, the S corporation reports its net profit or loss for the year, but they are the incomes and losses that are passed through to the individual owners who report to the IRS on their individual tax returns. The owners must report and pay personal income tax whether they received the earnings or not.
Example C Corporation
Imagine a C corporation that has a single shareholder and makes a profit of $500,000. If the business is a C corporation, it will lose about 21 percent or $105,000 of its profits to corporate tax. This will leave the owner with a dividend of $395,000. If the owners' personal income tax rate is 33 percent, then he would pay an extra $130,350 as personal income tax leaving him with $264,650.
Example: S Corporation
If the same business was an S corporation, the owner would not pay corporate tax, and the entire $500,000 would pass through as a dividend. This would be taxed at a rate of 33 percent or $165,000 leaving him with $335,000.
In both entity types, shareholders must pay income tax on dividends or distributions. From the 2018 tax year, personal income tax rates range from 10 percent to 37 percent depending on the amount earned. An S-Corp must issue every shareholder a Schedule K-1 that shows the portion of earnings allotted to them. Each shareholder reports the income on their K-1 on his personal returns.
Taxes on Benefits
C corporations are suitable for companies that want to give benefits like life insurance, health insurance, and disability insurance to owner-employees. C corps can deduct the cost of those benefits from the taxes of the shareholder if the Corporation actually offers those benefits to at least 70 percent of its employees. That deduction is not available to S corporations.
Drawing Money From the Business
Any funds drawn from the business by a C corporation shareholder is classified as a dividend and is subject to double taxation. The exception to this is when the money is a reimbursement for a business expense or a loan repayment. S corporation owners, on the other hand, can draw money from the business without being subjected to double taxation.
State Taxes Differences
On the state level, the differences between the two business types vary according to state. In some states, there is no difference in the way the state taxes the two types of corporations. In most states, both entity types must pay the following taxes:
- Franchise taxes. These tend to be higher for C-Corps compared to S-Corps.
- Sales tax–if the business is involved in selling.
- Workers' compensation insurance.
- Unemployment insurance.
- States also usually impose an extra lawyer of personal income tax on the incomes of both C corporation and S corporation shareholders.
The main difference in the tax treatment of the two corporation types is that some states only levy a state corporate on C corporations and not S corporations. This tax is in addition to the federal corporate tax. However, some other states levy the same tax on S corporations.
S-Corp status tends to favor small businesses while big businesses that have the goal of getting funds by selling stock globally do not qualify to be S-Corps.
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