Introduction - S corp vs C corp
The difference between C corporations and all the other entities is that C corps pay their own tax - they are not pass-through entities.
The corporation pays corporate income tax on its profits at the following rates:
Taxable income
$ %
0 - 50,000 15
50,000 - 75,000 25
75,000 - 100,000 34
100,000 - 335,000 39
335,000 - 10 million 34
If the owners then want to get their hands on the profits they have to pay themselves a dividend. Dividends are currently taxed at a maximum rate of 15%.
So C corporations are potentially taxed twice:
• Once at the corporate level, and
• Once at the shareholder level when dividends are paid.
Clearly this is unattractive and undesirable for most small business owners.
How to Avoid Double Taxation - S Corp Vs C Corp
Many small C corporations avoid this double tax problem by simply paying out all their profits as salaries and bonuses.
These amounts are tax deductible so the corporation ends up with no profits and doesn't have to pay any corporate income tax.
The owners then have to pay income tax at individual rates on their salaries, much like any other business owner.
To avoid paying dividends which are subject to double taxation, another strategy is to pay shareholders consulting fees. Of course, you have to make sure there is some genuine consulting. These consulting fees will, however, be subject to social security and Medicare taxes.
Income Splitting - S vs C Corp
Using a C corporation can actually save you tax if you need to keep money in the business to help it grow, for example if you need money to buy inventory or fund a marketing campaign.
This is called income splitting because instead of having all the income taxed in your hands at rates of up to 35% you can keep some in the corporation where it will be taxed at rates as low as 15%.
The first $50,000 of profits you keep in the corporation will be taxed at just 15% and the next $25,000 will be taxed at just 25%.
For this strategy to work your company must, of course, be earning surplus profits that you can afford to keep in the business instead of paying out for your personal living expenses.
Example
Larry's internet business, Larry Inc, has $75,000 of surplus profits that he would like to keep in the business to help it expand. Federal corporate tax will be as follows:
$
$50,000 x 15% 7,500
$25,000 x 25% 6,250
Total tax 13,750
If Larry was using a pass-through entity his marginal income tax rate on these surplus profits could be between 28% and 35%, meaning he would have to pay between $21,000 and $26,250.
By using a C corporation Larry has saved himself between $7,250 and $12,500 in tax!
And that's not the only tax saving. Earnings retained in the business are also not subject to the FICA tax.
In summary, by keeping up to $75,000 of profits in the corporation and paying the rest out as salaries and bonuses, most people can save some tax.
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