One of the most important decisions you’ll make as a business owner is choosing what type of entity to operate as. Your decision affects how you will be taxed. If you decide to incorporate you can operate either as a C-corporation or an S corporation or a Limited Liability Company (LLC).
For now, let’s focus on the C corporation. A C corporation is a separate legal entity apart from its owners. The corporation is responsible for all of its own transactions and can be sued separately from its shareholders. Corporations can be co-owned by a variety of individuals, partnerships, trusts, LLCs and other entities. In many cases, the corporate tax rate is much lower than the personal tax rate.
Under a corporation, the profits that are obtained through company activity are spent pre-tax, on company expenses. This might include paying salaries and wages, purchasing employee health insurance and buying machinery for the company. After all of the expenses are covered, taxes are paid on the remaining sum. Finally, any resulting profits are divided and paid as dividends to the shareholders.
Under this model, individual employees of the company will pay their own taxes, and shareholders will pay tax on their dividends. This can result in double taxation since dividends are paid and taxed after the corporate tax is applied. However, C corporations have the highest number of allowable deductions of any business type, and they are an excellent choice for companies with multiple fringe benefits offered, such as education assistance and employee insurance.
Pros:
— Anyone can be a shareholder in the business
— Liability is limited, so the owner does not become personally liable for the business
— Fringe benefits are deductible
— Greatest number of deductions available out of any business type
Cons:
— Higher administrative costs
— Expense of establishing the corporation
— Separate tax filing
— Double taxation
Understanding both the tax consequences and the operating procedures under each form of entity is vital to your success as a business owner.
Reminder: March 17th is the Corporation Tax filing deadline (The normal deadline is March 15th, but this date falls on a Saturday, so the deadline is pushed to the next business day).
Esther Phahla is a Certified Public Accountant and Certified Tax Coach in Temecula. She also holds a Masters of Science in Taxation. She can be reached at (951) 514-2652 or visit www.estherphahlacpa.com