- 1 S-Corporation Benefits
- 1.0.1 Tips for Small Business Owners
- 1.0.2 C-Corporation “Double Taxation”
- 1.0.3 Avoid C-Corp “Double Taxation” by forming an S-Corporation
- 1.0.4 Receipt of Written Approval from IRS
- 1.0.5 IRS Form 1120S filing for S-Corporations
- 1.0.6 S-Corporations file Schedule K and Schedule K-1
- 1.0.7 Investment Credits
- 1.1 S-Corporation Benefits
Avoiding “Double Taxation With An S-Corporation
Tips for Small Business Owners
C-Corporation “Double Taxation”
A C-corporation is a separate taxable entity and for this reason pays taxes on its earnings at the prevailing corporate tax rate which is filed and reported on a Form 1120. Then the individual shareholders pay taxes individually on the corporate dividends received. This is what is often referred to as “double taxation” of C-corporations.
For this reason many smaller C-corporations never pay out dividends, but retain profits within the company to fund further growth. If the long term intent is to create sufficient value so that it can be sold or taken public, this provides a tax-efficient exit strategy.
Avoid C-Corp “Double Taxation” by forming an S-Corporation
In order to offer small business owners an option to avoid the burden of “double taxation”, the IRS adopted the S-corporation status. By filing Form 2553, a C-corporation can elect to be taxed as an S-corporation. This means the corporation is taxed under Subchapter S of the IRS code. In order to obtain the S-corporate status with the IRS, the Form 2553 must be filed with the IRS, and must be approved by the IRS (it is not automatic upon filing). The corporation must meet certain IRS requirements to be eligible to file for Subchapter S status. Your corporation can only have one class of stock, a maximum of 75 shareholders, and can have no non-individual-non-people shareholders, with only a few exceptions. With only a few exceptions, an S-corporation cannot have another corporation as a shareholder.
Receipt of Written Approval from IRS
If you don’t receive written approval on your Form 2553 filing with the IRS within 2 months, you need to follow up. Since it’s just about impossible to contact anyone with the IRS to check the status, just refile the Form 2553.
Once you receive the approval letter from the IRS, your corporation will be taxed as an S-corporation. While a C-corporation is taxed as a separate taxable entity, an S-corporation typically pays no income tax. Rather, the S-corporation’s taxable income flows through to the individual shareholders.
IRS Form 1120S filing for S-Corporations
C-corporations file Form 1120 with the IRS. S-corporations file a Form 1120S which is usually an informational form with no tax due with the filing.
S-Corporations file Schedule K and Schedule K-1
The flow of income to the S-corporation shareholders is handled with the filing of a Schedule K (part of the 1120S) and Schedule K-1 (Shareholder’s Share of Income, Credits, Deductions, etc.). The Schedule K-1 takes into consideration each shareholder’s percentage of ownership in the S-corporation. A Schedule K-1 is sent to each shareholder for preparation of their individual income tax return.
Investment credits are currently provided to stimulate certain economic activity. The following is a list of these credits:
- Low-Income Housing Credit –
- Disabled Access Credit (Form 8826) –
- Credit for Small Employer Pension Plan Startup Costs (Form 8881) –
- Empowerment Zone and Renewal Community Credit (Form 8844) –
CONTINUED TO: S-Corporation Tax Strategies