A corporation or LLC is considered a entity onto itself; separate from the individual personal
assets of shareholders,
officers and directors.
A C-Corp is a corporation which remains a taxable entity within itself.
It pays corporate income tax rates, and the profit or loss does not pass through to the
individual's tax return. A C-Corp may, in fact, also be subject to personal holding
company surtax on the income. An even more serious consideration is the fact that C Corps are subject
to double taxation. The corp. pays taxes on profits, then the
shareholders pay tax on dividends received.
'S' corporation or LLC is essentially an entity which acts and
looks like a corporation but is taxed on the individual's tax return (merely
a tax code election). The flow-through
nature of this entity makes it the preferred vehicle for many
businesses. The corp. itself does not show profits or losses, they
must be passed on to the shareholders. If the corp. has a profit of
$100,000 for the year, the money is split among the shareholder
percentages. Each shareholder is liable for the taxes on the dividend
received. The same goes for losses! These are reported on form
K-1 on the Fed tax return.
A second reason for establishing an S-corp or LLC is that of asset
protection. An S corporation is a stand-alone entity, even though it is taxed on an
individual's tax return. Because of this, anybody suing you as an individual
generally be able to get to the assets of the S-Corp. Similarly, anyone
suing the S-Corp would not be able to get at the assets of the
individual outside of
the corporate entity. (the corporate entity must be properly maintained)
For these reasons, we have frequently
clients to start S-corps, limited liability companies, and/or limited partnerships.
Case Study: Employed individual with sub 'S' corporation
When Aubry Phillips, a registered nurse, decided to supplement her income by forming a new
online medical service. She
formed a corporation and elected the 'S corporation' option for
One important tax test of a valid 'S corporation' is that it has a
legitimate profit objective.
Whether the company profits or not, the income (or loss) effects personal ordinary income.
In the first year, Aubry had a loss from the corporation of $15,000. She was able to
deduct the corp.'s loss from her ordinary RN income of $60,000. Consequently, she
received a federal income tax refund of $4,500 and a state income tax refund of
Her refunds totaled $5,700 which Aubry invested into her business for year two.
Similarly, year two created another loss with the tax refunds
reinvested in the growth of the
corporation. By the end of year three, the corp. was profitable.
With the corp. Aubry was allowed several deductions based on company
expenses. A car was leased for the business, paid for by the corporation (the insurance as
well). She passed a corporate resolution allowing all medical expenses of the officers and
directors to be paid by the corporation. Her telephone, computer, web site, internet access,
advertising, legal, professional and promotional fees were all ordinary and necessary
expenses of the corporation. These expenses all contributed to her corporate losses and
resulted in her personal tax refunds.
This brief example demonstrates the purpose of the IRS Sub 'S' treatment by helping to
finance new business during their developmental stages. Also, eliminating double taxation
that large corporations are required to pay via a corporation tax and
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