An S-Corp is a type of corporation that receives specialized tax treatment based on its election in the Internal Revenue Code. For taxation purposes, S-Corps are treated as pass-through tax entities. This means that the business structure does not pay taxes at the organizational level. Instead, the profits or losses of the corporation are “passed-through” to the owners as the owner’s personal tax liability. Since taxes are paid only at the individual level, losses can be applied to other income to reduce the shareholder’s tax liability.

In contrast, C-Corp entities are separate and distinct from the ownership interests of the corporation. A C-Corp files taxes annually on its earnings on a separate tax return. When income is distributed to the corporate shareholders, then shareholders are taxed on those dividends. This is commonly referred to as double taxation and is a substantial disadvantage of incorporation as a C-corp.

Small businesses generally choose either a limited liability corporation or S-Corp as their structure. Both LLCs and S-Corps offer the distinct advantage of a single level of taxation – they do not pay taxes on the profits earned by the entity or the corporation. This allows owners to include business losses on their personal tax returns.  But there are other factors may be instrumental in choosing between these structures. For example, an S-Corp (like a C-Corp) has a number of regulatory requirements that may be onerous for some small business owners. In contrast, an LLC has significantly fewer administrative filings and documentation requirements which can conserve costs and resources. Another benefit of forming an LLC is that it provides an additional measure of flexibility in the event circumstances change. Specifically, in an LLC, the allocation of ownership interests and profits among business associates can be easily amended. In contrast, in an S-Corp, business associates are always taxed based on their ownership percentages.

Despite the clear advantages provided by an LLC, S-Corps have a significant tax-based incentive for their owners. Namely, S-Corp owners may divide earnings into wages and salaries. The distributions, in this case, are not subject to certain taxes. Given these tax based considerations, a business may opt to organize as an LLC and elect tax treatment as an S-Corp.

Contact Shane Coons at 949-333-0900 or visit his website at www.ShaneCoonsLaw.com to find out more about his practice.