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.
Corporation that wants to be taxed as a small business corporation will file a form with the IRS called Form 2553 and file their taxes using 1120s 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 pays taxes on the profits. The post tax income may then be distributed to the corporation shareholders in the 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 an individual level. This 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.
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:
- The 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)
An LLC like the S – Corporation provides for pass through taxation. An 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 S-Corporations or even a C – Corporation if it chooses.
Tax Advantages of the LLC:
- Multiple options in terms of taxation.
Extremely flexible in how it chooses to distribute profits which allows the owners to distribute profits or losses in ways that are advantageous to their tax situation.