Information About C Corporations for New Business Owners
Forming a Corporation can provide many benefits. The most important factor is that incorporation can help limit your personal liability as a business owner. Generally, creditors of your corporation must satisfy their claims by seizing the assets of the corporation rather than your personal assets. In contrast to a sole proprietor or partner in a partnership, you are financially responsible for all liabilities of the business, and your personal assets are subject to seizure or lien by creditors. Other benefits of incorporation can include greater tax deductions for pension and retirement expensing and funding, health insurance and medical expenses, lower payments for social security tax and Medicare tax, and greater opportunity to raise capital for the business through the issuance of stock.
A corporation is a legal entity created under the laws of a particular state. It is distinct from its owners, who are called shareholders and has its own legal existence.
According to the IRS as of 2011, there were 2.3 million C corporations, with approximately 97 percent of which with assets of less than 10 million dollars. For federal tax purposes, a C corporation is a separate taxpaying entity. It files its own IRS Form 1120 to report its income or losses. Shareholders do not report their share of the corporation's income and cannot claim any deductions of the corporation. C corporations pay taxes according to corporate tax rates. The current rates run from 15% to 35%. Earnings are taxed at the corporate level and when the earnings are distributed to the shareholder as a dividend, they are taxed again this time at the shareholder level and included in the shareholders individual tax return Form 1040. This process of being taxed at 2 levels is referred as "double taxation". The current maximum tax rate on dividends at the shareholder level is 15 percent
Business owners and entrepreneurs may choose to become a C corporation for the following reasons. They feel they may able to grow the company through reinvested corporate earnings. The dividend tax paid by the owners of the corporation is only levied at the point that dividends are actually paid out to the shareholders. If a corporation plans to retain earnings to fund growth, a C corporation may not cost that much more in taxes on a current basis than an S corporation does. If a corporation earns and reinvests modest amounts of profit in the business, the tax rates may be lower than at the individual level. Currently, the first $50,000 in profits that a C corporation earns may be subject to a low 15% federal corporate income tax. Also there are Tax-free fringe benefits for shareholder-employees.
Small corporations often employ their owners. This raises the tax planning opportunity of a C corporation providing tax-free fringe benefits to employees, including the shareholder-employees.
In other words, the corporation can make pension fund contributions or buy health insurance for employees. These expenditures are tax deductions for the corporation, but the benefits aren't taxed to employees. For many of these fringe benefits, the corporation needs to be non-discriminatory in the way it treats employees. With a pension plan, for example, the corporation needs to treat shareholder-employees and non-owner employees consistently. Some fringe benefits, such as accident and health insurance, the C corporation may be able to discriminate. This can provide shareholder-employees with generous tax-free income in the form of fringe benefits.
Not every corporation can qualify to be taxed as a subchapter S corporation. The IRS imposes a list of limitations and restrictions that the business and shareholders must meet and continue to comply with at all times. Some of the major ones include that there must be less than 100 shareholders. The shareholders must all be natural persons (with limited exceptions) and the shareholders must be based in the US. Also, there must only be one class of stock.
You can change from a C corporation to an S corporation by filing a 2553 form with the Internal Revenue Service and (when necessary) by filing an equivalent S election form with the state revenue agency. If you make an election to have a corporation treated as an S election at a point other than at the incorporation date, you need to be aware that an S corporation may pay C corporation taxes on income that it earned and on gains that occurred if that income was earned or those gains stem from the part of its corporate life when it was a C corporation. These taxes are typically called "built-in gain" taxes. If the corporation has earnings and profits it has retained from the period of time during which the corporation operated as a C corporation, when they're paid out to the shareholders, the shareholders will owe dividend taxes on them. Also, the retained earnings and profits can terminate the S corporation status if the corporation enjoys passive investment income (such as from real estate rental income) of more than 25% of its gross receipts for three years in a row.
Rosedale & Drapala, CPAs can help you prepare your C Corporation taxes.
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