Can corporate losses be deducted by the shareholders of a C corporation?
Corporate losses remain in a C corporation, and cannot be deducted by the shareholders, as they can be deducted by partners, shareholders, and members in the case of partnerships, S corporations, and LLCs. Deductions must be postponed until the corporation has income, and may be permanently lost.
Can excessive passive investment income affect S corporation status?
Where a corporation claims income from a passive investment (e.g. from real estate owned) for three consecutive years that exceeds 25% of the corporation’s gross receipts, S corporation status may be terminated by the IRS. Most real estate investors, for example, prefer placing real property in an LLC (Limited Liability Company) rather than an S-corporation for this very reason.
How is a C corporation taxed?
A corporation is a taxpayer in its own right, separate and distinct from its shareholders, and is taxed at the corporate tax rate. The individual shareholders are also taxed on dividends received from the corporation with no corresponding deduction to the corporation. This results in double taxation (the same money is taxed twice). This double taxation may be minimized by the payment of salaries to shareholders and by the use of shareholder loans. However, corporations issuing excessive or unreasonable salaries to their shareholders often face penalties from the IRS. Losses and deductions of a C corporation can be used, if at all, only to offset corporate income and gain, and cannot be deducted by the shareholders.
How is an S corporation taxed?
An S corporation is a corporation that has made an election with the IRS to be treated for tax purposes as a “pass-through entity.” This means that corporate profits and losses are passed through to the shareholders (owners) who report them on their own personal tax returns and pay the tax at the individual level. The corporation pays no federal income tax at the corporate level. S corporations are not subject to the double taxation C corporations encounter.
Should I form an S-corporation for tax reasons?
For federal tax purposes, it is often best for a start-up company to be an S-corporation rather than a C-corporation. Starting as an S-corporation rather than a regular C-corporation may be wise for several reasons:
- Income from an S-corporation is taxed at only one level rather than two – your total tax bill will likely be less.
- If your business operates at a loss the first year, you can pass that loss through to your personal income tax return, using it to offset income that you (and your spouse, if you’re married) may have from other sources.
- Interest you incur to buy S-corporation stock is potentially deductible as an investment interest expense.
- When you sell your S-corporation, your taxable gain on the sale of the business can be less than if you operated the business as a regular corporation.
What is self-employment tax?
An important issue to consider when deciding the structure of your business is self-employment tax. Self-employment (SE) tax is a 15.3% tax on income. This rate, 15.3%, is a total of 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).
The SE tax rate for business owners is 15.3% tax of the first $94,200 of income and 2.9% of everything over $94,200.
Normally these taxes are withheld by your employer. However, if you are self employed, it is your responsibility to pay them yourself.
S corporations have a significant advantage when it comes to the payment of SE taxes. In an S corporation, only the salary actually paid out an owner/employee as compensation for services is subject to SE tax. Any money left in the business for reinvestment or distributed to the shareholder as a dividend is not subject to payroll taxes…and not subject to self-employment tax.
Owners of sole proprietorships, partnerships and LLCs however, pay SE tax on their respective share of profits rather than salary. (Certain types of LLC income, however, are not subject to self-employment tax. For example, rentals from real estate and capital gains are not considered to be self-employment income, so real estate LLCs often need not be concerned with self-employment tax.)
Here’s an example: Say, this year, you have net income of $90,000 and pay yourself $60,000 in salary, leaving $30,000 in the business to pay for equipment. As a sole proprietor, you would pay self-employment tax on the full $90,000 ($90,000 x 15.3% = $13,770). But as an S corporation, you would only owe self-employment tax on the $60,000 in salary ($60,000 x 15.3% = $9,180), resulting in a savings of $4,590.
| SELF EMPLOYMENT TAX | |||
| Type of Tax | Tax Base | Rate | Maximum Tax |
| Social Security | $94,200 | 12.4% | $11,680.80 |
| Medicare | no limit | 2.9% | no limit |
How is a professional corporation taxed?
Professional corporations can be either “C” or “S” corporations. A professional corporation that has not made an S-election can be classified as a “personal service corporation” (PSC) by the IRS and is taxed at a flat 35-percent rate by the IRS.
In order to avoid being classified as a PSC by the IRS, most professional corporations opt for S-corporation status.
What is franchise tax?
There is a minimum state franchise tax of $800 for the privilege of doing business in California as a corporation. While LLCs must pay the minimum $800 tax in their first year of formation, corporations are not required to make payment until their second year of existence.
What is a fiscal year?
A fiscal year is an accounting year, for tax purposes, that does not end on December 31. A fiscal year must end on the last day of a month (other than December).
An accounting year ending on December 31 is a “calendar year.”
What is an Employer Identification Number (EIN)?
The EIN, often referred to as the Federal Tax Identification Number, is a number that is assigned to a business by the Internal Revenue Service. An EIN is like a Social Security Number for a business. It is a requisite for certain business functions such as opening bank accounts or hiring employees.
I have a Federal EIN for my existing business. Can I use the same one if I form a corporation?
No. If you already have an EIN (Employer Identification Number) for your business, you must apply for a new one upon formation of your corporation. Your new corporation may conduct business in exactly the same manner as your previous business entity, but it is a new legal entity and a new taxpaying entity. Therefore, it must be assigned a new EIN.