It can get confusing when you’re trying to figure out the pros and cons of structuring your company as a C Corporation or an S Corporation. There are some definite tax advantages of S Corp for general contractors, especially for the solo entrepreneur. So we thought we’d help shed some light on the subject.
What Is the Difference Between S Corp and C Corp?
While S Corporations and C Corporations may sound similar based on their names, there are some significant differences when it comes to how they can operate when it comes to formation, taxes, and ownership.
It’s not possible to say that one is better than the other. Each has strengths and weaknesses depending on how you want your business to function, both now and in the future. To help clarify the pros and cons between C and S Corporations for general contractors, let’s take a look at the 3 major categories where they are different.
1. Formation
a. How are C Corporations formed?
“C Corp” is the default designation when companies decide to incorporate. There is not a lot of paperwork involved. If you are thinking big and want to eventually sell your company to a larger corporation or seek additional funding, you may want to consider filing as a C Corp.
Each state has its own requirements, though, so be sure to find out what your particular state requires before making any decisions.
Our firm is located in Tennessee, so we can easily help…especially if you are in one of the 6 areas of the state where we have offices.
b. How are S Corporations formed?
Businesses who want to be designated as an “S Corp” are required to additionally file Form 2553 with the IRS. It is an extra step, but one that your CPA or business attorney can guide you through.
2. Ownership
a. How is C Corp ownership handled?
There are no limits on how many owners (a.k.a “members” or “shareholders”) a C Corporation can have. They can be made up of individuals or even other business entities from anywhere in the world. If you are starting a company that you expect to sell later, raise funding through investors, or intend to go public with on the stock market, a C corporation may be your best option.
b. How is S Corp ownership handled?
An S corporation is restricted to having a maximum of 100 shareholders. Each shareholder is required to be a U.S. citizen.
Having a smaller number of owners can lead to each one being more involved in the operations of your company, whether they are active or passive members. Employees can also be owners who benefit from profit sharing under this structure as well. For those reasons, you may want to consider the limitations of S Corp ownership.
3. Taxes
a. How Are S Corps Taxed?
Income and losses in an S Corp are reported on the individual owners’ tax returns. Under current tax law, in many cases, owners can deduct up to 20% of their business income on those tax returns. Plus, they are able to deduct business losses if the company has a negative year.
1. Single-member LLC taxed as an S Corp
If you form your business as a Single Member LLC (SMLLC), you can additionally elect to be taxed as an S Corp. Your business would continue to be considered a “pass-through entity”, meaning that the taxes on the company’s revenue would be paid on your individual tax returns.
You will also be required to file IRS Form 1120-S at the end of the year.
Nolo.com has a good article on “Electing S Corporation Tax Status for a Single-Member LLC” if you want to explore that topic further.
2. How Are S Corp Distributions Taxed?
S Corporation owners can also be employees of the company. As an employee, their wages are taxed at the appropriate individual tax rate on their personal returns. As an owner, they do not pay employment taxes on any distribution of profits that they receive. Those are simply taxed as income on the owner’s personal tax return.
The IRS does not allow S Corp owner-employees to only receive distributions as income. They must be paid a “reasonable” salary for the position they hold. This can be determined by checking common sources such as Salary.com or Glassdoor.com. Many accountants also apply a 60/40 rule where at least 60% of the individual’s total income must come from a salary rather than a distribution.
b. How Do C Corp Taxes Work?
C Corporations are taxed as a separate entity, then individual owners are taxed again on their own individual returns for any dividends they may take. This double taxation could be an unnecessary burden if your company is not expected to grow very large.
C Corps can deduct 100% of any charitable contributions the company makes (as long as they don’t exceed 10% of the business’s overall revenue).
c. Tax Advantages of S Corp for General Contractors
It is possible that you can realize some tax savings through an S Corp if you expect that your company will be able to distribute significant profits in addition to your salary. You also have the ability to write off any business losses on your personal taxes as well.
Let Us Help Guide You To Success
Knowing how to structure your company can be complicated, but it doesn’t have to be. We can help.
For further reading on this topic, take a look at another post we did recently titled “7 Pros and Cons of LLCs for General Contractors (and 2 Tax Options to Consider)”.
We’ve been in the business of helping small businesses with their taxes, company formation, and other services necessary for running a successful venture for over 40 years. Our business experts can help you find out which type of corporate structure is right for you. Give us a call at (731) 668-4482 or schedule a call to learn more!
