This article is original content written by Thomas Scanlon, CPA, CFP® of Manchester, CT.
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:
C Corporation
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.
S Corporation
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®
Tom Scanlon has over thirty years experience in public accounting with an extensive background in the areas of financial, tax, and estate planning. He prides himself on providing in-depth and customized solutions to privately held businesses and their owners. He is a Certified Public Accountant and Certified Financial Planner®. Tom is a frequent speaker for area organizations and has recently been quoted on CNBC, Fox 61 News and AARP's blog. Tom also has been a guest columnist for numerous publications including The Wall Street Journal, Barron's, Money Magazine, The Hartford Courant, The Hartford Business Journal, and The New Haven Register. He is a member of the American Institute of Certified Public Accountants, the Connecticut Society of Certified Public Accountants, and the Financial Planning Association. Active in the community, Tom supports a variety of not-for-profit organizations.
