Tax Q & A for Small Business Owners

What are the main differences between a C-corp and an S-corp?

C-corps are subject to double taxation, while S-corps provide pass-through taxation. S-corps have ownership restrictions, while C-corps do not. Ultimately, the choice depends on your business’s unique needs and goals.

How can an LLC be converted into a C-corp?

To convert an LLC to a C-corp, you’ll need to hold a meeting with LLC members, file Articles of Incorporation, obtain an EIN, issue stock certificates, adopt bylaws, and notify relevant parties. It’s a straightforward process, but it’s crucial to consult with legal and tax professionals to ensure a smooth transition.

How can a C-corp be converted into an S-corp?

To convert a C-corp to an S-corp, file Form 2553 with the IRS, ensuring all shareholders sign the form. The corporation must meet eligibility requirements, such as having no more than 100 shareholders and only one class of stock. Timing is essential, as the form must be filed within two months and 15 days of the beginning of the tax year.

What is built-in gains tax?

Built-in gains tax is a tax that applies to appreciated assets held by a C-corp at the time of conversion to an S-corp and sold within five years after the conversion. Proper planning and timing of asset sales can help minimize the impact of this tax.

Can an S-corp be converted back to a C-corp?

Yes, an S-corp can be converted back to a C-corp by filing a statement of revocation with the IRS. However, this decision should be carefully considered, as it may have significant tax consequences. Always consult with a tax professional before making such a change.

Can an S-corp have foreign shareholders?

No, an S-corp cannot have foreign shareholders. One of the eligibility requirements for S-corp status is that all shareholders must be U.S. citizens or residents. If your business needs to attract foreign investment, a C-corp may be a more suitable choice.

What is the difference between a shareholder and a partner?

Shareholders own stock in a corporation and have limited liability protection, while partners own a portion of a partnership and may have unlimited liability. Shareholders have a less direct role in managing the business compared to partners.

What are family attribution rules?

Family attribution rules are IRS regulations that determine how stock ownership is attributed among family members for tax purposes. These rules prevent the manipulation of stock ownership to avoid taxes or qualify for certain tax benefits. It’s essential to consult with a tax professional to ensure compliance.

What is an S-election?

An S-election is the process by which a corporation chooses to be taxed as an S-corp. To make an S-election, Form 2553 must be filed with the IRS by the 15th day of the third month of the corporation’s tax year. Once made, the election remains in effect until revoked or the corporation no longer meets the eligibility requirements.

Which states recognize an S-corp, and which do not?

Most states recognize S-corps and follow the federal tax treatment. However, some states, like New Jersey and New York, treat S-corps as C-corps for state tax purposes. Other states, like California and Massachusetts, recognize S-corps but impose a separate state-level tax. Always research your state’s specific tax laws and consult with a tax professional.

When starting a business, one of the most crucial decisions you’ll make is choosing the right legal structure. Two common options are C-corporations (C-corps) and S-corporations (S-corps). While both provide limited liability protection, there are significant differences between the two that can impact your business’s financial and operational aspects.

C-corps are the default corporate structure and are subject to double taxation, meaning that the company’s profits are taxed at the corporate level, and then shareholders are taxed on any dividends they receive. C-corps have no restrictions on ownership and can have an unlimited number of shareholders, including foreign investors.

On the other hand, S-corps are a special tax election that allows the company to be taxed as a pass-through entity, similar to a partnership or LLC. This means that the company’s profits and losses are passed through to the shareholders’ personal tax returns, avoiding double taxation. However, S-corps have several restrictions, such as a maximum of 100 shareholders, all of whom must be U.S. citizens or residents, and only one class of stock.

If you’re currently operating as an LLC and wish to convert to a C-corp, the process is relatively straightforward. You’ll need to hold a meeting with LLC members to discuss and approve the conversion, file Articles of Incorporation with your state’s Secretary of State office, obtain an Employer Identification Number (EIN) from the IRS, issue stock certificates to the shareholders, adopt corporate bylaws, and appoint a board of directors. It’s essential to consult with a legal professional and a tax advisor to ensure that the conversion process is completed correctly and in compliance with state and federal regulations.

To convert a C-corp to an S-corp, you must file Form 2553, Election by a Small Business Corporation, with the IRS. The form must be signed by all shareholders and filed within two months and 15 days of the beginning of the tax year when the election is to take effect. To be eligible for S-corp status, the corporation must meet specific requirements, such as having no more than 100 shareholders, only one class of stock, and only allowable shareholders (U.S. citizens, residents, and certain trusts).

When converting from a C-corp to an S-corp, it’s important to be aware of the built-in gains tax. This tax applies to any appreciated assets the corporation held at the time of the conversion and sells within five years after the conversion. The built-in gains tax is imposed at the highest corporate tax rate (currently 21%) on the net recognized built-in gain, in addition to any other taxes the S-corp shareholders may owe on their share of the gain. Proper planning and timing of the sale of appreciated assets can help minimize the impact of the built-in gains tax.

If you later decide that an S-corp no longer suits your business needs, you can convert back to a C-corp by filing a statement of revocation with the IRS. The statement must be signed by shareholders holding more than 50% of the outstanding shares of stock. Once the revocation is effective, the corporation will be treated as a C-corp for tax purposes. However, it’s crucial to consider the potential tax consequences of this decision and consult with a tax professional before making the change.

One important limitation of an S-corp is that it cannot have foreign shareholders. If your business needs to attract foreign investment, a C-corp may be a more suitable choice.

When discussing business ownership, it’s essential to understand the difference between a shareholder and a partner. A shareholder owns stock in a corporation and has limited liability protection, meaning their personal assets are generally not at risk for the company’s debts and liabilities. Shareholders also have the right to vote on certain corporate matters, such as electing the board of directors. In contrast, partners own a portion of a partnership and have a more direct role in managing the business. They share profits and losses based on their ownership percentage and may have unlimited liability for the partnership’s debts and obligations, although limited liability partnerships (LLPs) and limited partnerships (LPs) can provide some protection.

Family attribution rules are another important consideration when choosing between a C-corp and an S-corp. These IRS regulations determine how stock ownership is attributed among family members for tax purposes, preventing the manipulation of stock ownership to avoid taxes or qualify for certain tax benefits. Under family attribution rules, an individual is considered to own the stock held by their spouse, children, grandchildren, and parents. It’s essential to consult with a tax professional to ensure compliance with these rules and avoid unintended consequences.

Think about an S-Election

An S-election, also known as an S-corp election, is the process by which a corporation chooses to be taxed as an S-corp under Subchapter S of the Internal Revenue Code. To make an S-election, the corporation must file Form 2553 with the IRS by the 15th day of the third month of the corporation’s tax year to be effective for that year. Once the S-election is made, the corporation will be treated as an S-corp for tax purposes, and its profits and losses will be passed through to the shareholders’ personal tax returns. The S-election will remain in effect until it is revoked by the corporation or the corporation no longer meets the eligibility requirements for S-corp status.

While most states recognize S-corps and follow the federal tax treatment, there are some exceptions. States like New Jersey and New York do not recognize S-corps for state tax purposes and instead treat them as C-corps. In these states, the corporation may be subject to state corporate income tax, and shareholders may be subject to state personal income tax on their share of the corporation’s profits. Additionally, some states, such as California and Massachusetts, recognize S-corps but impose a separate state-level tax on the corporation’s income. It’s crucial to research your state’s specific tax laws and consult with a tax professional to understand the implications of operating an S-corp in your state.

Ultimately, choosing between a C-corp and an S-corp depends on your business’s specific needs, goals, and circumstances. By understanding the differences between these two structures and the various factors that can impact your decision, you can make an informed choice that best serves your business’s interests. Always consult with legal and tax professionals to ensure compliance and optimize your business’s tax strategy.