Posted by The TaxAdvocate Group, LLC

C vs. S Corporation: Filing a Tax Return

C vs. S Corporation: Filing a Tax Return

Promoters of a business may choose to set it up as either an S corporation or a C corporation. How do S corporation and C Corporation differ as a business status for filing a tax return? In this article, we take a look at what opting for either type of business would imply to filing a tax return for the business.

Corporation Basics

We will consider the differences between the two after we see what a C Corp and S Corp status have in common.

A corporation is owned by shareholders. Business operations are overseen by directors elected from among the shareholders for the purpose. Officers hired by the directors operate the business on a day-to-day basis. The shareholders receive a share of business profits (dividends) proportionate to their shareholding. To form a corporation, the promoters must prepare a document known as articles of incorporation, and file registration documents with the respective state in which the business is headquartered.

The various requirements of a corporation include the issuance of stock, adoption of by-laws, the holding of annual shareholder and director meetings, maintenance of minutes of meetings, the issuance of written corporate resolutions relating to important decisions, and filing of annual reports with the state government and payment of fees every year.

If a corporation fails to comply with these requirements, its members could lose protection from personal liability, and the corporation could be dissolved.

Owners of a corporation who set it up are provided with limited personal liability. State laws help oversee the setting up of a corporation which enjoys a legal identity distinct from those of its owners. Thus, any corporate debt would only bind the assets of the corporation and but for some exceptional cases absolve a shareholder from personal liability for the corporate debt, and business creditors can have no legal claim on assets of a shareholder.

C Corporation vs. S Corporation: Formation

Corporations are generally formed as C Corporations. Filing of IRS form 2253 (relating to Election by a Small Business Corporation) will help turn a C corporation into an S corporation, for federal taxation purposes. State tax purposes may be served by filing a state form that would accord the corporation an S Corp status. The Internal Revenue Code has provisions in its Subchapter S of Chapter 1 to permit the conversion of a C Corp status to an S Corp status. The definition of "S Corp" has thus been derived from the "s" subchapter of the code. Promoters of corporations that operate on a calendar year basis must seek a change of status to S Corp on or before March 15 of the relevant tax year. Promoters of corporations that operate on an alternate fiscal year basis must seek a change of status to S Corp on or before the 15th of the third month of the relevant fiscal year. Said promoters may choose to fill form 2253 on any day in the previous tax year.

S Corporation vs. C Corporation: Taxation

Saving on tax is a clear motivation for the promoters of a corporation with a C Corp status to seek change to an S Corp status. Depending on the status, the corporation would be taxed differently.

Federal Tax

A C Corp would have to pay federal taxes on its profits and report such taxes on its corporate tax return. Dividends to shareholders from after-tax profits would again be taxed on the returns of individual shareholders who would have to report such taxes on their returns. Thus, a C Corp status attracts double taxation. Electing to choose an S Corp status would enable a corporation to ensure that such double taxation does not happen. To calculate federal taxes, an S corporation is treated as though it were a sole proprietorship or partnership concern. The S Corp passes its profits to shareholders as dividends, and only the shareholders are taxed based on their returns.

State Tax

A similar method of the passing of profits or losses to shareholders of an S corporation is practiced in many states, though a few states do subject S corporations to double taxation.

C Corp vs. S Corp: Ownership

The law allows greater flexibility to a C Corp in the matter of selling of shares of stock. The IRS mandates that a corporation that seeks S Corp status must have 100 shares at most, and must restrict itself to issuing only one class of stock. Such S Corp must not have any non-US citizens or non-residents as shareholders, nor must it count among its shareholders, any other S corporation, a C corporation, a partnership, or an LLC. Various trusts are also named as ineligible to be shareholders of an S corp. 

These restrictions are exclusive to S corps. Thus, a C Corp that is not subject to such restrictive rules can aim to grow larger. Thus a C Corp can seek business capital from shareholders without allowing such shareholders voting rights, thanks to the ability to issue different classes of stock.

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