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.
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.
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.
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.
Your decision to be an S-corporation isn’t permanent. If you later find there are tax advantages to being a regular corporation,
you can easily drop your S-corporation status.
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.
SELF EMPLOYMENT TAX
|Type of Tax
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.
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.
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.”
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.