A corporate structure is more complex than other business structures. It requires complying with more regulations and tax requirements. It may require more accounting tax preparation services than the sole proprietorship or the partnership.
Corporations are formed under the laws of each state and are subject to corporate income tax at the federal and state level. In addition, any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal tax returns.
The corporation becomes an entity that handles the responsibilities of the organization. Like a person, the corporation can be taxed and can be held legally liable for its actions. If you organize your business as a corporation, you are not personally liable for the debts of the corporation.
When you form a corporation, you create a separate tax-paying entity. Unlike sole proprietors and partnerships, income earned by a corporation is taxed at the corporate level using corporate tax rates. Regular corporations are called C corporations because Subchapter C of Chapter One of the Internal Revenue Code is where you find general tax rules affecting corporations and their shareholders.
A corporation files Form 1120 or 1120-A, U.S. Corporation Income Tax Return,. . If a shareholder is an employee, he pays income tax on his wages, and the corporation and the employee each pay one half of the social security and Medicare taxes and the corporation can deduct its half. A corporate shareholder pays only income tax for any dividends received.
The Subchapter S corporation is a variation of the standard corporation. The S corporation allows income or losses to be passed through to individual tax returns, similar to a partnership. The rules for Subchapter S corporations are found in Subchapter S of Chapter One of the Internal Revenue Code.
An S corporation has the same corporate structure as a standard corporation. It is a legal entity, chartered under state law, and is separate from its shareholders and officers. There is limited liability for corporate shareholders. The difference is that the corporation files an election on Form 2553, Election by a Small Business Corporation, to be treated differently for federal tax purposes.
Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income. It is treated in the same way as a partnership, in that generally taxes are not paid at the corporate level.
An S corporation files Form 1120S, U.S. Corporation Income Tax Return for an S Corporation. The income flows through to be reported on the shareholders’ individual returns. Schedule K-1, Shareholder’s Share of Income, Credits and Deductions, is completed with Form 1120S for each shareholder. The Schedule K-1 tells shareholders their allocable share of corporate income and deductions. Shareholders must pay tax on their share of corporate income, regardless of whether it is actually distributed.