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To Be or Not to Be: a C or S Corporation
This Blog is from our firm's CPA Jonathan Mayo that I thought I would share with any designer or small business owner. Let's face it — taxes must be paid. That said, as business owners we need to ensure we are not overpaying them so we can reinvest profits into our companies and grow them.
I feel like designers really need to know about this stuff cause well, if you are like me, you learn this stuff the hard way. I'd like to save you some of the financial pain. Your corporate structure can impact the amount of tax you pay and even increase the odds that the IRS will audit you. I have asked Jonathan to share the tax benefits of a C and S corporation. From Jonathan Mayo CPA:
First of all let me say I'm not an attorney and am in no way attempting to practice law. When it comes to entity choice, there is no substitute for incorporation advisory from a qualified attorney.
That said, from a CPA's standpoint, like an LLC, both the C and S corporations offer limited liability, that is, the owner's personal assets are protected from the liabilities of the business. The process of setting up either type of corporation is similar; I always recommend paying a good attorney around $500 to set up any business entity.
Often corporations are seen by the general public, and by lenders, as more legitimate than a sole proprietor or LLC. Having "Inc." behind your name means that you've had to follow certain regulations and seems more professional.
Both forms have a much lower IRS audit rate than a Schedule C sole proprietor or single member LLC.
Both corporations issue shares to the owners, pay the owners a reasonable salary for their services, and issue the owners W2s at year-end. Owners' salaries are a deduction to the corporation, and taxable income to the owner (just like any wages).
Both have a board of directors to manage daily affairs (usually comprised of the owners, in a small business situation), and both must follow corporate rules such as issuing stock and having a yearly shareholder meeting.
I highly recommend using a payroll service when running a corporation. For a small company with a couple/few employees, this generally costs $1200-$1500 per year. Also, each type of corporation files a yearly income tax return. Most accountants who know what they are doing will charge around $1000 to prepare a corporate income tax return.
Usually (depending on your state) there are a few more minor corporate filings each year, so the cost of maintaining a corporation is around $3,000 per year. For this reason, I usually recommend a sole proprietor or single member LLC for business where the profit (including shareholder salary) will be under $70,000 per year. Once profits go above $70,000, there are some corporate tax advantages that can make up for that $3,000 per year, and much more in some cases.
It is very rare that I will recommend a C-Corporation.
C-corporations come with the possibility of double taxation for their owners. The shareholders take a reasonable salary each year through payroll and get a W2 each January. The corporation files its own tax return (Form 1120) and pays tax on any profits. The shareholders can only take out money through payroll, or as dividends, so profits may be taxed twice (once at the corporate level, once as dividends on the shareholders return.
C-corporations do have more relaxed rules about who can be a shareholder than S-corporations. S-corporations may only have one class of stock, are limited to 100 shareholders, shareholders must be US citizens, and an S-corp. generally may not be owned by another business entity. For these reasons, C-corps can be sold easier, and might be the right choice for a company using venture capital, one with a lot of investors, or one that is going to be sold quickly. It is also easier to offer C-corporation shareholders fringe benefits, but this rarely makes enough difference to have it be a deciding factor on entity choice.
In an S-corporation there is no double taxation. The corporation does not pay tax on its profits on its yearly income tax return. Instead, any profits "flow through" to the shareholders tax return, and taxes are paid at the shareholders ordinary income tax rate.
Example: A corporation has $100,000 profit before shareholder's salaries. It pays its one shareholder $60,000 per year, which is a reasonable salary for someone providing similar services in the same industry.
If this were a single member LLC or sole proprietor, the entire $100,000 would be subject to self-employment tax, total federal and state income tax would be around $36,000.
If this were an S-corporation, the owner saves on Social Security and Medicare on the difference between salary and profits; approximate total tax is $31,000.
If this were a C-corporation, it would be best to pay out the total salary as wages to avoid double taxation. The shareholder still pays around $36,000 in taxes, plus her state's unemployment tax for the year (which would hopefully be only a few hundred $). If the corporation only paid $60,000 in wages, the shareholder pays about $20,000 in taxes, the corporation pays about $10,000, and if the shareholder wants to take the money out, they'll pay another $9-10,000 on the dividend distribution, totaling close to $40,000 total taxes.
You can see how the S-corporation is the most advantageous here, and actually saves the shareholder money even after paying all of the costs to maintain the corporation.
Jonathan Mayo CPA
Tax Experience CPA Inc
100 E 23rd St Ste 3B
Baltimore, MD 21218