C Corporation Business Tax Lawyer Chicago
C Corporation and S Corporation Differences
A C Corporation is taxed as a separate entity and must report profits and losses on a corporate tax return. The C Corp pays corporate taxes on its profits while the shareholders are not taxed on the corporation’s profits. C Corp shareholders report and pay income taxes only on what they are paid by the corporation. Now when the corporation chooses to pass along any of its after-tax profits to shareholders in the form of dividends, the shareholders must report those dividends as income on their personal tax returns even though the corporation has already paid corporate taxes. This is commonly referred to as “double taxation”, something that is avoided with an S Corporation (a pass-through tax entity).
While an S Corporation with more than one shareholder does file an informational K-1 tax return, the corporation itself does not pay any income taxes. Instead, the individual shareholders (owners) must include their share of the corporation’s profits on their personal tax returns, paying tax at their individual tax rate.
S Corporations provide another advantage should the corporation experience losses. Unlike C Corporation shareholders, S Corp shareholders are allowed to offset other income by including their share of the corporation’s losses on their personal tax returns provided, however, they cannot deduct corporate losses in excess of their “basis” in their stock – that being the amount of their investment in the company, with a few adjustments.
Keep in mind that no more than 25% of an S Corporation’s gross corporate income may be derived from passive income.
While both C Corporations and S Corporations are allowed to provide employee benefits that are deductible by the corporation and tax-free to the employees, the tax-free status of some fringe benefits is not nearly as generous for S Corporation shareholders who own more than 2% of the corporation’s stock.
Since the corporate tax rate is typically lower than an individual’s tax rate and profits retained in the corporation will not be double taxed as dividends, a C Corporation can generally accumulate capital more effectively than an S Corporation. Of course an S Corporation could accumulate even more capital if it did not distribute any of its profits to the shareholders – but doing so would create obvious problems for some owners who would have to pay income taxes.
Each S Corporation shareholder must be a U.S. citizen or resident. C Corporations can have multiple classes of stock while S Corporations are limited to one class of stock (voting rights can differ).
S Corporations are not allowed to conduct certain kinds of business. Business corporations that are not eligible for S Corp status include banks, insurance companies taxed under Subchapter L, Domestic International Sales Corporations (DISC), and certain affiliated groups of corporations.
Generally speaking, C Corporations offer more flexibility than S Corporations and are therefore the best choice for large companies with a large numbers of shareholders, especially if they are publicly traded.
C Corporations can choose when their fiscal year ends while an S Corporation’s fiscal year end must be December 31. If a C Corp has been using a fiscal year end other than December 31, it must change to a December 31 fiscal year end if it converts to an S Corp. And if the S Corp status is later revoked, it cannot change from the 12/31 fiscal year.
C Corporations not considered a small corporation ($5,000,000 or less in gross receipts) are required to use the accrual method of accounting while only those S Corporations that have inventory must use the accrual method of accounting.
Conversion from C Corp to S Corp
A C Corporation can make its original conversion to an S Corporation at any time after being originally formed by filing a Form 2553 with the IRS. A few states require that an S election also be filed with the state. In cases where a C Corp is converted from an S Corp, it must remain a C Corp for at least 5 years before it can be converted back to an S Corp.
Conversion of an S Corp back to a C Corp
An S Corporation can convert back to a C Corporation anytime by filing a formal request with the IRS. However, the C Corp must keep the December 31 fiscal year and it cannot convert back to an S Corp for at least five years (restrictions that hamper the ability to save taxes by shifting income between taxable years, a strategy practiced by some). It can sometimes be more beneficial to form a brand new C Corporation rather than converting.
C Corporation and S Corporation similarities
Both C Corporations and S Corporations are legal entities and treated as individuals under the law.
Both C Corporations and S Corporations are initially the same, regular corporations (C Corporations) created by officially filing what is normally called Articles of Incorporation or a Certificate of Incorporation with a state.
Both C Corporations and S Corporations have unlimited life, continuing to exist after the death of owners.
Both C Corporations and S Corporations are made up of shareholders who are owners of the corporation, directors (elected by the shareholders) who make major management decisions, and officers (elected or appointed by the board of directors) who are responsible for the day to day operations of the corporation.
C Corporation Business Tax Lawyer Chicago