Entrepreneurs can set up their small business as a sole proprietorship, corporation, S-corporation, C-corporation, partnership, non-profit organization, Limited Liability Company, Limited Liability Partnership, and in some states a Professional Limited Liability Company/Partnership. With so many choices available, which form of organization is best suited for your business depends on several factors, some of which are tax-related. When you think about the date that taxes are due, April 15th comes to mind. However, if your business is a S-Corporation or a C-Corporation, your business tax returns are due on March 15th. With the deadline for tax returns quickly approaching, here are 8 things you should know.
While there are a variety of designations at the state level, for federal tax purposes there are only 6 forms of business organizations:
- Sole Proprietor (Form 1040 Schedule C or Schedule F)
- C-Corporation (Form 1120)
- S-Corporation (Form 1120S)
- Partnership (Form 1065)
- Trust (Form 1041)
- Non-profit organization (Form 990)
1. Limited liability company (LLC) can be treated (for tax purposes) as many different kinds of business organizations. Limited Liability Company is not listed above because an LLC can pick which tax treatments apply whether it is a sole proprietor, a partnership, a C-corporation, or an S-corporation. By default, an LLC with just one owner is considered a disregarded entity, with the result that the LLC is treated for tax purposes in the same way that the owner of the LLC is taxed. By default, an LLC with two or more owners is considered a partnership. Alternatively, an LLC can opt out of the default treatment by electing to be treated as a Corporation instead. After electing to be treated as a corporation, owners of an LLC can further elect to be treated as an S-corporation.
2. An S-Corporation is not actually a business entity. An S Corp is a tax election made with the IRS that allows a business to be taxed as a sole proprietor or partnership. Often referred to as a “pass-through” entity, an S-Corporation reports corporate profits and losses are passing through the shareholder’s personal tax returns and are assessed tax at their individual income tax rates. This allows S-Corporations to avoid double taxation on the corporate income.
3. S-Corporations avoid double taxation. Since a corporation is a totally separate entity from its owners, avoiding double taxation is a key incentive for many business owners. Furthermore, if you are self-employed, one way to help avoid or reduce high Social Security and Medicare taxes is to organize your business as an S-Corporation.
For example, as an S-Corporation shareholder, you’ll be taxed based on your percentage of ownership. If you own 25 percent of an S-Corp that is profitable for the year, then you will need to pay taxes on 25 percent of the profits (i.e. if the company brings in $100,000 in profit, you’ll pay taxes on $25,000).
On the contrary, when a C-Corporation makes money, its first point of taxation is when it files it’s tax return and pays taxes directly on those profits. When corporation takes its profits and distributes them to shareholders, those distributions will get taxed as well, but this time on the shareholder’s personaltax return. Therefore, those corporate profits are taxed twice: first with the corporation’s tax returns, then a second time on the individual shareholder’s personal return.
4. General Corporation Tax (GCT)
New York City does not recognize Federal or New York State “S Corporation” elections and subjects S Corporations to the General Corporation Tax. This tax is effective for tax years beginning on or after January 1, 2015, applying to corporations that are S-Corporations and qualified subchapter S subsidiaries under the IRS.
Who has to pay this tax?
All domestic and foreign corporations in New York City that are:
- Doing business
- Employing capital
- Owning or leasing property, in a corporate or organized capacity; or
- Maintaining an office.
Who is Exempt from the Tax?
- Dormant corporations, which did not engaged in any business activity or held title to real property located in New York City;
- Corporations subject to the New York City Banking Corporation Tax or Utility Tax, except vendors of utility services which are subject to the General Corporation Tax;
- Corporations organized to hold title to property as described in Sections 501(c)(2) or (25) of the Internal Revenue Code;
- Insurance Corporations;
- Nonstock not-for-profit companies that are granted an exemption by the New York City Department of Finance; and
In New York City, the General Corporation Tax is imposed on all corporations at a rate of 8.85% because NYC does not recognize federal or New York State S corporation elections. This leaves New York corporations subject to paying their taxes to New York City, New York State, and the Internal Revenue Service.
5. C-corporations are taxed on their net income. C-corporations are taxed on their net income, the gross income minus allowable deductions for various business expenses. Shareholders who perform services through the corporation are employees, and pay federal income tax, Social Security tax, and Medicare tax on their salary. S-corporations generally don’t pay any corporate tax. Instead, S-corporations divide their net income among their shareholders, and the income is taxed on each shareholder’s personal tax return at ordinary tax rates.
6. No Self-Employment Tax!
The big benefit and incentive of S-corporations is that S-corporation shareholders do not have to pay self-employment tax on their share of the business’s profits. However, there’s a catch. Before there can be any profits, each owner who also works as an employee must be paid a “reasonable” amount of compensation (e.g., salary). This salary will of course be subject to Social Security and Medicare taxes to be paid half by the employee and half by the corporation. The only caveat is that the savings from paying no self-employment tax on the profits only kick in once the S-Corporation is earning enough that there are still profits to be paid out after paying the mandatory “reasonable compensation.”
7. Not everyone can file for S Corporation treatment. The IRS places strict guidelines on who can and cannot be an S Corporation. In general, S Corporations have fewer shareholders, the shareholders are individuals, and you only have one class of stock. Specific guidelines include:
- An S-Corp cannot have more than 100 shareholders
- All shareholders in an S-Corp must be individuals (not LLCs or partnerships) and legal residents of the United States.
- An S-Corp can have only one class of stock, so all shareholders need to pay taxes strictly based on their percentage of ownership
8. The approaching deadline. For existing C-Corporations and S-Corporations, you have until March 15 to take the S Corp election for 2015. Your S-Corp is required to file IRS Form 1120S (Corporation Tax Return) before March 15th. After your Form 1120S is complete, you must distribute K-1’s to your shareholders by March 15th as well. Since there are strict deadlines this paperwork, make sure to plan ahead or your S Corporation treatment will not begin until 2017. If you elect to treat the LLC as a corporation for tax purposes, you must file an annual IRS Form 1120 by April 15, 2016.
For legal help regarding your S Corp or C Corp call or visit the business attorneys at Fisher Law Group today: Fisher Law Group, P.C. 25 Broadway Fl 9 New York, NY 10004 (212) 256-1877