There is a C-Corporation which is the major corporations like those you see on the stock market. C-Corporations have stockholders, and they can make a lot of money. They have corporate meetings and boards of directors’ meetings and so on. They pay 21 % corporate income tax on the profits that the corporation makes.
Then they pay their shareholders in dividends and the shareholders pay individual taxes on the dividends they receive. This is referred to as double taxation, as they are taxed on the individual and corporate level.
There are reasons corporations do this. One reason is that they do not have much choice. They are often too big to be treated as S-Corporations. There are advantages to being a C-Corporation. They can be listed on the stock market. They are attractive to investors.
The small businessman is usually better served by the S Corporation. The other type of corporation is called an S-Corporation. An S-Corporation is a small business corporation. It has limits on how much money it can make. It can’t have more than 100 shareholders. It cannot have foreign investors. A major thing about an S-Corporation is that the income it makes automatically flows through to its shareholders, so it never makes taxable income as a corporate entity. It all gets credited to the individuals who own it, so there’s no double taxation.
The S-Corporation is not taxed at the federal level. Some states (e.g. California, Tennessee) tax S-Corporations at the state level. This decreases but does not eliminate the S-Corporation’s tax advantage in these states.
An S-Corporation is called a flow through entity because its profit or loss flows from the federal corporate return to the individual stockholder’s return. Limited Liability Companies, Partnerships, and Sole Proprietorships also flow through entities. The business profit or loss flows from the business to the individual 1040 tax return.
So, what is the advantage of the S-Corporation? These other entities (LLCs, Partnerships, and Sole Proprietorships are also flow through entities BUT are automatically subject to the Self Employment (SE) Tax. This is the Employer’s and Employee’s contribution to Social Security and Medicare COMBINED, i.e. 15%.
On $100,000 of profit this is $15,000 In SE Tax in addition to Income Tax. OUCH!
Now, an S-Corporation can save much of this money. The taxpayer will need to file an S-Corporation tax return form 1120S. Moreover, the corporation will need to pay reasonable compensation to shareholder employees and pay them on a payroll.
For a small business making $30-300K profits per year, this is often worthwhile. If you are curious about how this might affect your taxes, you are welcome to contact us for a free consultation.
There are also asset protection advantages to S-Corporations and LLCs. Asset Protection is commonly underprioritized by business owners and this can be a major mistake. You are welcome to contact us at Guard Dog Tax and Torchlight Tax (these are sister companies) and we can review the benefits of an S-Corporation for your exact situation.
Now, there is one other entity that’s not actually a corporation, but everybody thinks it is. It’s called a limited liability company, or LLC.
Now, the funny thing about an LLC is that it can apply to the Internal Revenue Service to be treated for tax purposes as an S-Corporation.
Now a C-Corporation, if it meets the qualifications, can also apply to internal revenue service to be treated for tax purposes as an S-Corporation.
This is because S-Corporation is a tax status, not an entity.
LLCs and Corporations are formed as entities at the state level. They can apply for S-Corporation tax status at the federal level.
If an LLC does not apply for S-Corporation tax status at the federal level, it is viewed by the IRS as a disregarded entity. If this occurs, a single member LLC would file as Sole Proprietor. An LLC with more than one member would file as a Partnership.
Now if a corporation does not file for S-Corporation tax status, the IRS will treat it as an S-Corporation.
For most small businesses, there is little practical difference between an LLC or Corporation.
Fees can be different. Corporations sometime have extra requirements. Feel free to contact us if you have any questions here.
I realize some of these points may seem unnecessarily complex or picayune.
Hi, my name is Bruce Roth, and my guest today is Dave Horwedel. Dave is the founder of Torchlight Tax and Financial Services. He is also an enrolled agent and tax expert in Las Vegas, NV. What is the best business structure for taxes? What type of corporations and corporate entities there are? And why one might choose one over the over?
I want to mention that I’m talking about the tax implications of this, and I’m not practicing law. But, there are two actual types of corporations.
The Best Business Structure for Taxes
There is a C-Corporation which is the major corporation. The C-Corporation has stockholders and they make a lot of money. They usually have corporate meetings and boards of directors meetings. And it’s a big deal. They actually have to pay corporate income tax on the profits on the profits that the corporation makes.
And then as they pay their shareholders in dividends, the shareholders have to pay individual taxes on the dividends they receive. That’s the big corporations, called a C-Corporation.
The other type of corporation is called an S-Corporation. An S-Corporation is a small business corporation, it has limits on how much money it can make. It can’t have more than 100 shareholders. But the main thing about an S-Corporation is that the income it makes automatically flows through to its shareholders, so it never makes an income as a corporate entity. It all gets credited to the individuals who own it, so there’s no double taxation.
And this is a very, very common thing that a small businessman. A self-employed person, they can become an S-Corporation, and they can have tax benefits for them. And it also shields them legally.
Now, there is one other entity that’s not actually a corporation, but everybody thinks it is. It’s called a limited liability company, or LLC. Now, the funny thing about an LLC is that it can apply to internal revenue service to be treated tax wise as an S-Corporation, and in my cases this will give them a significant break as far as the self-employment tax, social security, Medicare. So, there’s actually only two types of corporation really, there’s the C, then I have the S. But there’s also the LLC, that kind of half rates as one, and it’s something that people should be aware of. And it can have definite tax implications for how you do it, and you could also do it to shield yourself from lawsuits and things like that.
The visible costs of Payroll and Bookkeeping can be truly daunting. These two areas have been the bane of many small business owner. The visible costs include not just the cost of the service, but also the cost of not doing it right. All too often, the small business owner gets into tax trouble because of their books. They cannot file a timely return, or files an inaccurate one, and winds up with heavy tax penalties. Or perhaps he has tens of thousands of dollars of perfectly legitimate expenses disallowed because his bookkeeping did not support them.
Payroll can be even worse. The penalties for not forwarding payroll taxes are brutal. Every small businessman has heard these horror stories. The vigor of the IRS in pursuing unpaid Payroll Tax and the penalties exacted make routine IRS collection activities seem tame.
With visible costs like this, it is no wonder that Small Business owner turns to QuickBooks. It seems that you cannot even watch a sporting event on TV, without seeing a QuickBooks ad. How can he be safe and run his business without adequate bookkeeping and payroll? Well he can’t. For many small business owner, QuickBooks seems the answer. Their business is small, and they are or become adept at bookkeeping and payroll using QuickBooks or similar software. They can monitor their income and expenses, file their taxes, and carry on their business.
But what then are the hidden costs?
I will illustrate this by example, one businessman had built a small business grossing about $1.5 million dollars a year. He brought all his QuickBooks and bank and tax data in to our firm to do his taxes, and it was a mess. His tax return could not be filed without extensive bookkeeping, which he paid for. This cost is visible. Where then is the hidden cost?
He had spent 2-3 hours a day all year working on his books. He was the creator and production manager of his business, and had plenty of work to do. But he spent this daily time on his books, and he knew it was important. What did this cost his business? Probably $300,000 in lost income. When he was handling the production and sales of his firm, income flowed in.
What did he get for all this book work? Bad Books.
He even had a secretary who could have been trained up to handle the books.
The hidden cost of bookkeeping and payroll is two-fold:
The income not generated because the owner or key manager is doing books or payroll when he could be running the business to make income.
The profit lost because the bookkeeping is inadequate and the manager does not see exactly what is making money, and what is losing money, and thus cannot take appropriate informed actions to increase profits.
The visible costs can be high enough. Paying the bookkeeper or paying the IRS because of bad bookkeeping or payroll is easily, if painfully, visible. For some, the hidden costs may be small. Maybe you enjoy doing bookkeeping and payroll, and keep your records spiffy and up-to-date in just a few minutes per day (you know, like the guys and gals in the QuickBooks TV Ads). Maybe this does not affect your firm’s income at all.
However, if you make the business run and the income flow in, and are not a great bookkeeper, this hidden cost may be killing you. Your time might be better spent in making more money for the firm, or hanging out with the family.
What to do?
If you have any questions or need any bookkeeping or tax assistance contact GuardDog Tax for a free consultation. We are a tax firm, but we cannot do taxes when when poor bookkeeping obscures the income and expenses of a person or company. So we must be bookkeeping experts as well. No matter how bad your records are something can be done about it. It is far less expensive to pay the bookkeeper to get your books in order than to pay the IRS with bad books.
As the tax deadline approaches, contact us ASAP. We can still file for a tax extension for your C-Corp or sole proprietorship while we get your books in order so we can do your taxes.
One of our Enrolled Agents (top federally credentialed tax expert) will assist you. Email us or call our Toll Free Number (877) 758 7797.