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Advantages to S Corporations Versus C Corporations - S Corporation Tax Advantages

Many businesses incorporate for tax savings, but these savings can greatly vary depending on whether you are forming a S corporation or C corporation. The greatest of the advantages to S corporations is that unlike C corporations, S corporations avoid double taxation. A C corporation is taxed at both the corporate and individual level. The corporation itself is taxed on business profits and shareholders must also personally pay additional income tax for any money they draw from the corporation, including salary, dividends, or bonuses. Conversely, all S corporation profits "pass through" to the shareholders who then pay tax on their personal tax returns for these profits, similar to the taxing of sole proprietorships, partnerships, and LLCs. The S corporation itself pays no income tax. Forming a S corporation allows you to truly incorporate for tax savings.

Another of the S corporation tax advantages can be realized through distributing money from the S corporation to shareholders-employees as profits rather than as salary. The reason for S corporation tax advantages in this instance stems from the fact that profits are not subject to the over 15% in Social Security and Medicare taxes that salaries are. Because these S corporation tax advantages are regulated by accounting procedures, speak with your accountant about incorporating for tax advantages.

One of the other S corporation tax advantages is that when you sell an S corporation, the taxable gain on the sale of the business can be less than that of a C corporation.

Other S Corporation Benefits

Other S corporation benefits include all of the following, which are shared by S and C corporations.

Limited Liability. The corporate entity generally shields shareholders and directors from the debts and obligations of the company. In contrast, in a partnership or sole proprietorship, the owner's personal assets are at risk and may be used to pay business debts.

Issue Stock. One of the other advantages to corporations versus other alternatives is that they can issue stock. The sale of stock is the easiest way to attract outside investors and is one of the advantages of an S corporation over a LLC, which issues membership certificates instead of stock.

Continual Existence. Those who do not know about S corporations are surprised to learn that a corporation's existence is continual and not dependent upon its owners. If an owner dies or sells his interest, the corporation continues to exist and do business unless formally dissolved. This is one of the S corporation benefits over sole proprietorships and most partnerships, which dissolve upon the death or sale of an owner, limiting the salability of these types of businesses.

Asset Ownership. S corporations can be used to own property such as real estate or other assets due to S corporation tax advantages and for protection from liability.

S Corporation Disadvantages

Considering all of the S corporation benefits and S corporation tax advantages, there are relatively few S corporation disadvantages. The most notable of S corporation disadvantages are the strict requirements needed to become a S corporation, including:
  • Each S corporation shareholder must be an U.S. citizen or resident.

  • The S corporation can never have more than 75 shareholders.

  • S corporation profits or losses must be allocated in direct proportion to ownership interests.

Ignorance about S corporations and following their requirements can cause businesses to inadvertently break one of these rules and lose their S corporation status. More importantly, these businesses lose all of the S corporation benefits and S corporation tax advantages.

Another of the S corporation disadvantages versus C corporations is that S corporations may not deduct the cost of fringe benefits provided to employee-shareholders that own more than two percent of the corporation.

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