Question

A lot of small companies file their tax returns as a 1040 Sch C (Sole Proprietor) Since corporate tax rates are lower than Individual tax rates, doesn't it make sense to create a corporation, and file your small business taxes as a corporation Form 1120? What are some of the issues and benefits of filing as a corporation instead of as an Individual? One solution that has been discussed is to create another tax rate for individuals who file their business taxes as a pass-through on their individual income Sch C tax return - would this work?

Answer 1

Similarities:

• Limited liability protection: Corporations offer limited liability protection, so shareholders (owners) are typically not personally responsible for business debts and liabilities. This is true whether it is taxed as a C corporation or an S corporation.
• Separate legal entities: Corporations (C corps and S corps) are separate legal entities created by a state filing.
• Filing documents: Formation documents must be filed with the state. These documents, typically called the Articles of Incorporation or Certificate of Incorporation, are the same regardless of whether you choose to be taxed as an S corporation or C corporation.
• Structure: S corps and C corps have shareholders, directors and officers. Shareholders are the owners of the corporation, but it is the corporation that owns the business. The shareholders elect the board of directors. The board oversees and directs corporation affairs and decision-making but is not responsible for day-to-day operations. The board elects the officers to manage daily business affairs.
• Corporate formalities: The state corporation laws make no distinction between C corporations and S corporations when it comes to compliance responsibilities. All corporations are required to follow the internal and external corporate formalities and obligations, such as adopting bylaws, issuing stock, holding shareholder and director meetings, maintaining a registered agent and registered office, filing annual reports, and paying annual fees.

Differences

For small business owners evaluating S corporations vs. C corporations, the decision usually comes down to how they want the corporation to be treated for federal income tax purposes.

• C corporations: C corps are separately taxable entities. They file a corporate tax return (Form 1120) and pay taxes at the corporate level. They also face the possibility of double taxation if corporate income is distributed to business owners as dividends, which are considered personal taxable income. Corporate income tax is paid first at the corporate level and again at the individual level on dividends.
• S corporations: S corps are pass-through taxation entities. They file an informational federal return (Form 1120S), but no income tax is paid at the corporate level. The profits/losses of the business are instead “passed-through” to the business and reported on the owners’ personal tax returns. Any tax due is paid at the individual level by the owners.
• Personal income taxes: With both C corporations and S corporations, personal income tax is due both on any salary drawn from the corporation and from any dividends received from the corporation.