Tax Treatment of Business Entities Part 4: C Corporations
Startup business owners must consider the legal and tax considerations associated with selecting a particular type of business structure. This is the fourth part of a series of blogs on the tax treatment of business entities. This blog will address the tax treatment of corporations, often referred to for tax purposes as C corporations.
Like an individual person, a corporation may be taxed and held legally liable for its actions. Individual shareholders are generally not personally liable for the debts of a corporation. This is one of the primary reasons that corporations are formed. When one or more individuals form a C corporation, they create an entity with two separate types of taxpayers, the corporation, and the shareholders. As a separate tax-paying entity, a corporation files Form 1120 or 1120-A, U.S. Corporation Income Tax Return.
The term “C Corporation” is, of course, used to describe a type of business entity whose profits are taxed separately from its owners under subchapter C of the Internal Revenue Code. This is in contrast to an S corporation where profits are passed on to its shareholders and reported on their individual tax returns.
Corporations are formed under the laws of each state and subject to corporate income tax at the federal and state levels. Individuals exchange money and/or property for stock in the corporation upon its formation. Typically, a corporation computes its income using the same deductions as a sole proprietorship. A corporation may additionally take special deductions allowed by the Tax Code. For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity that conducts business, realizes net income or loss, and distributes profits to shareholders.
Corporate profits are taxed to the corporation when earned and then taxed a second time to shareholders when distributed as dividends. The corporation may not take a tax deduction for dividends distributed to its shareholders, nor may individual shareholders deduct any loss of the corporation.
A C corporation pays income tax at corporate tax rates, which are distinctly different from personal income tax rates. It may deduct all ordinary and necessary business expenses, including rent, employee salaries, and other operating expenses. Shareholders who are employee pay income tax on wages, while the corporation and the employee each contribute 50% of Social Security and Medicare taxes, with the corporation allowed to deduct its half of this contribution.
As corporate structures are more complex than other business structures, primarily because of compliance requirements with various rules, including tax regulations, it is wise to consult with an experienced and knowledgeable tax professional to help any business assess their current tax situation looking ahead to the future. If you are a business in the New York or Tri-State area and have any question about taxes, especially in planning ahead for the next filing season, call THE TAX EXPERTS at the Thorgood Law Firm www.thorgoodlaw.com. For a FREE consultation call 212-490-0704.