Case Study: S Corporation Vs. Corporation

Our client, Mr. Perez wants to start a new business, but he is debating whether to start a S corporation or a C corporation due to potential environmental factors associated with his business. He wants to maintain a limited liability and wants to avoid double taxation by paying himself a salary equal to his companies before tax earnings. He also would like to issue preferred stock to his son in the future to keep his interests in the business. He was advised by his friend to choose a C Corporation to maintain maximum flexibility in the business.
Issue and Conclusion
Is it more beneficial for Mr. Perez to incorporate his business as an S Corporation or C Corporation?
Considering the facts provided, S Corporation structure will be more beneficial
for his new business.
Analysis
It is essential to select the appropriate corporate structure for your business, which will have legal and tax implications. The structure you choose can ensure the success of your business in future. Most startups probably operate as either an S Corporation or a C Corporation due to their limited liability. As both offer limited liability protection, so shareholders (owners) are not individually reliable for business debts and liabilities. The owners' personal liability is generally limited to the amounts invested and loaned. However, if your company is an S Corp, you can usually write off startup costs as losses on your personal tax return. In a C Corp, startup costs creating tax losses can only be developed at the business level and offer no future benefit if the new company has future tax profits.
In order to avoid dual taxation, you could pay the money out as salaries to you and any other corporate shareholders as a realistic compensation for their work performed and pay employment taxes.
This is only possible through an S corporation, where taxation "passes through" to the company's owners, who report their share of profits and losses directly on their personal income tax return. S corporations are therefore not necessitated to file taxes on the business level. C corporations, on the other hand, have a double layer of taxation. They have to file taxes with the Internal Revenue Service, and the owners are required to report dividends received from the company on their personal tax return. Thus, by paying yourself a rational salary and paying dividends at regular intervals over the year, you can greatly reduce your chances of being questioned by IRS and can still decrease your overall tax burden by lowering your employment tax
liability.
Section 1.1361-1(e)(3) of Subchapter S describes that the shares owned by members of a family are treated as owned by one shareholder and can only issue common stock. However, Reg. § 1.1361-1(1)(1) allows the voting and non-voting rights among the shareholders of the corporation. This is particularly helpful when shareholders of family-owned S corps want to begin passing ownership to their heirs, but still want to retain control of the company. C Corporations on the other hand have availability of multiple classes of stocks, but the stockholders who owns the company's stock and are responsible for electing the directors, amending the bylaws and articles of incorporation, and approving major actions taken by the corporation.
Owners of both the S and C corporations can also raise additional capital by and transfer ownership by selling stock.
Even though a C corporation is the more flexible of the corporate structures and it may be more beneficial to large businesses in terms of raising capital since it is not restricted to just number of shareholders and for this privilege it faces tax implications. S Corps on the other hand have limitations on number of shareholders (100) and should only be U.S. citizens and resident aliens, the S Corp provides a comparatively simple business structure, which accepts payment of employment reimbursement and regular distribution of profits without tax at the corporate level. The structure also offers better clarity as to what amounts paid to the active owners will be subject to employment tax. Thus in the start-up phase of the business, an S-corporation can be a more fortunate organization from a tax standpoint during the early loss
years.