Question

When operating a business the calculation of taxable income is important as it is the basis for determining the amount of tax that must be paid on the income of the business.

How is taxable income computed by the business if it is operated as a "C" corporation, and "S" corporation or a partnership?

Answer 1

C-Corp:

C-Corps pay taxes at the corporate level first. After that, individual shareholders pay taxes on dividends paid by the corporation. This opens up certain shareholders to double-taxation.

The prospect of double taxation daunting, but it is an avoidable problem. Let’s examine how it works: First, a C-Corp doesn’t pay taxes on every dollar it earns. Rather, C-Corps deduct their operating expenses from their revenues, reducing the business’s taxable income. So if a company brought in $100,000 in revenue for a fiscal year but spent $65,000 in operating expenses, the taxable income of the business is $35,000, not $100,000.

Secondly, shareholders in a C-Corp only get taxed if dividends are distributed to them by the company. If a C-Corporation chooses not to provide dividends to shareholders and instead retain profits, double taxation is avoided since no dividends exist. In other words, only if a C-Corp makes a profit and distributes dividends to shareholders will double-taxation come into play.

S-Corp:

S corporations are responsible for paying three taxes at the corporate level: excess net passive income, the LIFO recapture tax, and built-in gains tax.

The excess net passive income tax and the LIFO recapture tax only apply when an S corporation was previously a taxable C corporation, or if the S corporation went through a tax-free reorganization with a C corporation.