Most small business owners eventually decide to incorporate in order to limit their liability. However, many do not realize that the type of corporation they choose can affect their tax situation immensely. It is important to understand the differences between an S corporation election and a C corporation so you can make an educated decision about this matter.
S corporation Election: Tax Consequences
One of the main differences between an S corporation and a C corporation is in how they are taxed. A C corporation is basically taxed twice: the profits are taxed, and then the shareholders/owners pay taxes on any profits they are paid. When you go through process of becoming an S corporation, you instead only pay taxes on the profits you are paid as shareholder. This is effectively almost halving your taxes. However, all businesses are considered C corporations as a default unless they go through the process of S corporation election.
What Qualifies as an S Corporation?
Incorporation as an S corporation is a better idea for most businesses due to the tax ramifications. However, there are several criteria that you must meet. An S corporation by US law can only have one hundred or less shareholders. In addition, these shareholders all must be US citizens or legal residents. There are special considerations if you have different classes of stock that should be discussed with a certified public accountant. Most small businesses in the United States qualify for S corporation election, and should file the paperwork so they can be taxed as an S corporation.
There are benefits to remaining a sole proprietorship or an LLC. However, if you decide to form a corporation, S corporation status is the best option for most American small business owners. Once you file as an S corporation, you will remain so until circumstances change. This is a one- time investment in halving your tax bill, which should be attractive to many people who are managing or receiving income from a small business.
