Business owners can maintain their corporation as a regular or “C” Corporation. Alternatively, if they are eligible, they may want to make a Subchapter S Election. Both are treated as separate legal entities. Here are the differences however:
While a C Corporation is a separate legal entity, it is also a separate taxable entity. The corporation will pay income taxes on any taxable income reported.
With a C Corporation there is more flexibility with regards to selecting a tax year end. A C corporation can pick any month it wants as its year end. This may be important for a seasonal business that wants a year end other than December.
Another advantage with a C Corporation is that health care premiums paid are currently treated as a tax free fringe benefit to the employees. Additionally, long term care premiums can be paid and can also be a tax free fringe benefit.
The biggest downside to a C Corporation is the likely double tax on sale of the business. Many buyers do not want to buy the stock (shares) of a company. This is because of the liability attached with it. Additionally the buyer would not get any depreciation or amortization if they bought the stock. Therefore many transactions become asset purchase agreements where the buyer buys the assets of the company. This results in a corporate tax on sale and a tax when the proceeds are distributed to the stockholders. It is for this reason that many growing businesses elect Subchapter S Status.
Although an S Corporation is a separate legal entity, it is not a separate taxable entity. The profits and losses of the company ‘flow-through’ to the stockholders of the corporation.
An S Corporation is generally not as flexible as a C Corporation. As a practical matter, most S Corporations have selected a December year end as their tax year.
An owner of an S Corporation will receive a W-2 for any wages they earn in their capacity as an employee. Additionally, stockholders of S corporations will receive a K-1 which documents their portion of the profits and losses of the company. These will be reported on their individual income tax return.
The biggest advantage to a Subchapter S corporation is the prospect of a single tax on sale of the business.
ACTION ITEM: Business owners need to understand the difference between a C Corporation and a Subchapter S Corporation.
Thomas F. Scanlon, CPA, CFP®