Friday, June 18, 2010

S-Corporations: What are they and why care?

Overview of S-Corporations and C-Corporations

There are two types of corporations for purposes of federal taxation. C-Corporations and S-Corporations. C-Corporations are your grandfather's traditional corporation. C-Corporations, like Intel, Dupont or Exxon, pay tax at the entity level with graduated tax rates up to 35%. Then, in addition, any employees of the C-Corporation pay taxes on their wages and shareholders pay taxes on their dividends. S-Corporations are different. S-Corporations are pass-through tax entities like partnerships. What is pass-through taxation? The S-Corporation pays no tax at the entity level. Rather, the S-Corporation shareholder pays taxes on their share of the income as reported on their K-1s. The S-Corporation shareholder/employee also pays income taxes and employment taxes on wages received. Finally, the S-Corporation shareholder pays taxes on any dividends. Thus, S-Corporations are said to avoid the double taxation of C-Corporations, although the matter is more complex than that.

Benefits and Limitations of S-Corporations vs. C-Corporations

1. Double Taxation.

One of the big benefits of S-Corporations is the avoidance of double taxation of the C-Corporation shareholder/employee. As referenced above, the C-Corporation pays taxes, then the shareholder/employee pays their income taxes and employment taxes on payroll received. In contrast, the S-Corporation shareholder pays their share of the S-Corporation's taxable income, but deducts any salary or dividends paid to the shareholder, thus avoiding double taxation. Although this is generally true, S-Corporation shareholders who own 2% or more of the corporation's stock will be taxed on some of the benefits received, which would normally be non-taxable to C-Corporation shareholders, thus incurring a double taxation to the extent of these benefits. These benefits taxed to the S-corporation shareholder include:

  • (a) Group term life insurance;

  • (b) Accident and health insurance plans;

  • (c) Meals and lodging;

  • (d) Employee death benefits;
In addition, S-Corporation shareholder(>2%)/employees cannot participate in "cafeteria plans".

Next article, the Triangle Business Matters Blog will address additional S-Corporation limitations and benefits, including the exclusion from employment taxes of dividends paid to S-Corporation shareholder/employees.

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