By: Michael D Siggins, CPA 6/17/10
Whether incorporating or choosing how your LLC or corporation is taxed, it's important to know the differences between subchapter S corporations and subchapter C corporations. Below is a general summary on the taxation of the two and their differences. Not included are the slight differences for various fringe benefits, retirement plans, and other more complex issues that vary on a case-by-case basis. A couple of assumptions and disclaimers:
- These are rounded, general numbers that will vary on a case-by-case basis, in particular the S-corporation tax calculations
- The S-corporation's income is the sole source of taxable income for the hypothetical individual. Income from other sources will change the tax significantly as different tax brackets will be entered or exited
- The hypothetical taxpayer in this example is married filing a joint return
- No consideration is given for deductions, exemptions, or tax credits on a personal level as these vary wildly
- This is intended as a stand-alone analysis and I encourage anyone reading this to contact myself or another CPA as to the implications of choosing your S-corp or C-corp election as results will vary significantly on a case-by-case basis
- The corporations have one owner, that for which the analysis is done
- All profits from C-corporations are distributed as dividends and all of these dividends are qualified dividends
- The tax basis of S-corporations is never negative
- Deductions for the corporation's share of payroll tax are ignored
S corporations and C corporations both have their strengths and weaknesses. From a tax perspective, S corporations can carry a lighter tax bill, but require a little more attention throughout the year, especially if profits vary signficantly year by year. A C-corporation pays tax on the corporate level and the shareholders pay a tax on dividends received from the corporation on the shareholder level. Often, this is referred to as double-taxation. A caveat of the C-corporation is the lack of requirement for an officer salaries. Currently, the corporate tax rates are as follows:
Income ($) Tax Rate
0-50,000 15%
50,001-75,000 25%
75,001-100,000 34%
100,001-335,000 39% *Rates change from 10M+, but this article only
335,001-10M 34% deals with corporations that make under 10M
Individuals also pay a 15% tax on qualified dividend distribtuion from C-corporations
S-corporations do not pay tax on the corporate level. The profits flow-through the shareholder's individual tax return, similar to partnerships. The individual is taxed on the S-corporation's taxable income, not on their distribution from the company. The extra work that is required is in the form of payroll. Nothing can be changed retroactively after the year ends, so it requires continuing involvement with your CPA throughout the yaer. The IRS says that the sole shareholder of an S-corporation must pay himself a "reasonable salary" in order to be exempt from self-employment tax on corporate profits.
*A note on the self-employment tax - An LLC taxed as a partnership must pay self-employment tax on all profits until they meet exemption threshholds. The self-employment tax is essentially the payroll tax that W-2 employees would pay for FICA and Medicare. This amounts to a 15.3% tax assessed at the individual level (less a deduction for 7.65%).
This reasonable salary must be commensurate with the shareholder's experience, education, and expertise as will be determined on an individual basis. For the sake of this analysis, I assume a reasonable salary is $50,000. Below are a couple of scenarios and their tax outcomes:
1. The corporation makes a $50,000 profit.
S-corp (50k salary) C-corp (50k sal) C-corp (no sal)
Officer Salary FICA/Med $ 7,650 $ 7,650 $ 0
Tax on corporate profits 0 0 7,500
Tax on Salary 6,669 6,669 0
Dividends tax 0 0 7,500
Total Tax 14,319 14,319 15,000
2. The corporation makes a $75,000 profit.
S-corp (50k salary) C-corp (50k salary) C-corp (0 sal) C-corp (75k sal)
Salary FICA/Med $ 7,650 $ 7,650 $ 0 $ 11,475
Tax on corp profits 4,450 3,750 13,750 0
Tax on Salary 6,669 6,669 0 11,131
Dividends tax 0 3,750 11,250 0
Total Tax 18,769 21,819 25,000 22,606
3. The corporation makes a $100,000 profit.
S-corp (50k salary) C-corp (50k salary) C-corp (0 sal) C-corp (100k sal)
Salary FICA/Med $ 7,650 $ 7,650 $ 0 $ 15,300
Tax on corp profits 10,700 7,500 22,250 0
Tax on Salary 6,669 6,669 0 17,119
Dividends tax 0 7,500 15,000 0
Total Tax 25,019 29,319 37,250 32,419
It is clear that if you can predict your profitability for the year ahead, through effective planning, you can reduce your tax liability significantly. In the last exampe, an effectively-elected and organized corporation could save over $12,000 a year in taxes. That's over a 12% tax break on income and almost a 1/3 less tax than a poorly elected and organized corporation.
Analysis can be done on a sliding scale and every person is unique, so be sure to weigh all options and contact your tax advisor before embarking down a certain path.
