You’ve decided to form a corporation as your business entity. Deciding whether the corporation should be a “separate” entity or “pass-through” entity for purposes of income taxes is the next major decision that you will have to make.
A S Corporation receives “pass through” taxation; in other words, while a corporation is a separate entity and “person” in the eyes of the law, a S Corporation is not taxed at the corporate income level. Rather, it is only taxed once at the ownership/dividend level. A C Corporation receives “separate” or double taxation. Unlike a S Corporation, the C Corporation is taxed first at the corporate level, and then again at the ownership/dividend whenever the corporation pays those out. Supposing one has a choice in becoming a C or S Corporation, there are several things that need to be considered.
One of the most important reasons for choosing a C Corporation is that fringe benefits for the shareholder-employees receive favorable tax treatment. In short, the cost of certain qualified fringe benefits is deductible by the employer but excluded from the gross income of the employee. This is particularly important, considering the corporation’s payment of health insurance to a shareholder would be one such deduction. C corporations, moreover, have traditionally been taxed at lower rates than individuals; thus, it was plausible to accumulate corporate assets in the coffers at lower rates. This, however, seems to be the way of the past, given that the tax rate for C Corporations is fairly in line with the individual income tax rate. But, if Congress considers a cut in the corporate tax rate, this reason could be back in play.
A S corporation’s biggest advantage over the C Corporation is the pass through tax treatment. There is one level of taxation as opposed to two. But, this can sometimes be problematic. Shareholders are taxed on the corporation’s income regardless of whether it is actually paid out. It is possible, then, that shareholders could pay taxes on money they have not received because it is sitting in the corporate coffers on standby.
There are a lot more consideration to take into mind, but the above are the most important.