It all starts with an idea. The idea grows into a plan, then a business. Somewhere along the way, the budding business owner picks a business entity. It may all come down to whether he or she should form an S corporation or a C corporation.
All corporations are required to file formation documents with their state government. By default, all corporations are C corporations. A corporation must file an election to go from “C” to “S.”
According to the IRS, corporations that meet the following criteria can qualify as S corporations:
- Be a domestic corporation,
- Consist of shareholders that are individuals, certain types of trusts, and estates, but not partnerships, corporations, or non-resident alien shareholders.
- Have up to 100 shareholders, but no more.
- Issue only one class of stock.
Some corporations are not eligible to be S corporations:
- Certain financial institutions,
- Insurance companies,
- Domestic international sales corporations.
A C corporation must file a Form 2553 Election by a Small Business Corporation with the IRS to be considered for S corporation status. This election should be done within 75 days of formation.
Taxes are one area where S corporations may have an advantage over C corporations. That’s because S corporations are pass-through entities when it comes to federal income taxes. The business itself is not taxed (we’re referring to federal taxes). Income is instead reported on the owner’s personal tax return.
The Tax Cuts and Jobs Act have evened the playing field and make the double taxation less of an issue until January 1, 2026. S corporations do have to file a Minnesota S Corporation tax return. The company may have to pay Minnesota’s 9.8% corporate tax rate on some income.
C corporations are taxed twice. Corporate income is taxed, but the shareholders also pay tax on the distributions or dividends they receive.
Oftentimes, the answer to which form of business should be adopted involves a cocktail of solutions, especially with the Tax Cuts and Jobs Act passage.
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