Tax Liability Requirements of Corporations
Before sorting out the tax liability requirements for different corporations, it is best to know what these corporations means. There is a fine line of difference between what an S Corporation, a C Corporation, and an LLC are. To begin with, a C Corporation is a traditional corporation and an LLC is a limited liability company. On the other hand, S Corporations can be elected by LLCs or C corporations to be taxed in accordance. In simple words, both LLCs and C Corporations can choose the tax liabilities of an S Corporation. Now that we know the basics, let’s take an in-depth look at the tax requirements of these corporations.
S Corporations are not liable for Self Employment Tax, which accounts for tax savings. However, owner cum employees are liable for a reasonable salary before any profits are distributed. This salary is subject to Medicare taxes (same amount as Self Employment Tax) and social security. Therefore, the tax savings are only effective when the business has a healthy income. You should also be aware of the fact that S Corporations have a much more complicated tax liability and legal status from LLCs. When you form an S Corporation, you must know that you will spend significant billed hours with your attorney and accountant.
C Corporations, unlike other corporate structures, are taxable. In simple words, a C Corporation is taxed on income, unlike other corporate structures where the income can be passed on to the owner(s) and then they are taxed for it. If your purpose of forming a corporation does not involve distributing the profits, then you can benefit from a C Corporation and using the income splitting strategy. The idea here is to split the income of the business so that a portion of the taxable income goes to the corporation and the other portion goes to the owner(s). Hence, this allows you leverage by lowering the tax bracket and saving tax money along the way. However, the biggest disadvantage for a C Corporation in terms of tax is that dividends (distributed profits) are liable for double taxation. In simple words, the corporation is liable for taxes on the income, and the shareholders are also liable for taxes on the dividends they received.
Additionally, just like S Corporations, C Corporations have a more complicated structure in terms of taxes, accounting, and legal status as compared to sole propriety, partnerships, and LLCs. Because of this reason, C Corporations are subject to fairly significant accounting and legal costs.
There are many other implications that come into play, like the tax liabilities when either of these two corporations makes losses. Though the Franchise Tax is waived off in the first year for S Corporations, LLCs have to pay this tax to the CA Franchise Tax Board in their first year. While there is only a degree of flexibility in S Corporations for distribution of profits and lesser flexibility in C Corporations, LLCs are allowed greater flexibility on how they distribute their profits or losses.
[Image Via: Idiva]