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Which Entity Offers the Best Tax Advantages?

There are two main types of corporations: the S Corporation and the C Corporation.

Every corporation is considered a C Corp when it is formed with the Secretary of State. The distinction is made on a federal level and processed by the IRS.

Corporations that want to be taxed a small business corporation file a form with the IRS called Form 2553 and will file their taxes using an 1120-S tax return. Corporations that do not file this form are taxed as traditional corporations and file the 1120 tax return.

A C Corporation files a corporate tax return and will pay taxes on the profits. The post-tax income may then be distributed to the corporation shareholders in the form of dividends. The shareholders are then taxed on dividends, which effectively forces the ownership of a corporation to pay taxes on the same earnings twice — once at the corporate level and then at the individual level. This is what is known as “double taxation.”

An S Corporation is similar to a limited liability company in the sense that the profits of the company flow directly to the shareholders. This is known as pass-through taxation. The profits of the S Corporation are distributed proportionally to share percentages.

Tax Advantages of an S Corporation:

  • Ability to limit self-employment tax, which can result in considerable self-employment tax savings

Pass-through taxation allows the profits of the company to flow directly to the ownership and only be taxed once.

Tax Advantages of a C Corporation:

  • Corporate tax rates are typically lower than personal income tax rates

Because corporate tax rates are lower, companies that have retained earnings can take advantage of the lower rates.

Limited Liability Companies (LLC)

The LLC, like the S Corporation, provides for pass-through taxation. The LLC is considered a disregarded entity and its tax treatment depends on the number of members. A single-member LLC is taxed as sole proprietorship, while an LLC with more than one member is taxed as a partnership. A very unique advantage of the LLC is that it can elect to be taxed as an S Corporation or even a C Corporation if it chooses.

Tax Advantages of the LLC:

  • Multiple options in terms of taxation

An LLC is extremely flexible in how it chooses to distribute profits, which allows owners to distribute profits or losses in ways that are advantageous to their tax situation.

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