C vs. S corporations


Tread carefully when changing entity status

Many businesses make the switch from C to S corporation status in order to save taxes. Doing so can help companies avoid the double taxation that happens when C corporation earnings are taxed at the corporate level and again when they’re passed through to shareholders as individuals.

S corporations are pass-through entities, so their earnings bypass corporate taxes and are taxed at the individual level only. Thus, businesses organized as C corporations can often cut their taxes considerably by becoming S corporations.

But wait: This doesn’t necessarily mean that making the switch is always the right thing to do. You might sacrifice some C corporation benefits by changing your entity structure to an S corporation.

Mapping the pros and cons

Note that issuing different types of common stock shares also can violate this rule. For example, if one set of common stock shares is awarded a higher percentage of the company’s profits, this would result in a second class of shares, which wouldn’t be allowed for an S corporation. However, S corporations can allow different voting rights for different shares of stock without creating a new class of stock.

Factoring in the ACA

The Affordable Care Act (ACA) has added a new variable to the C vs. S corporation decision-making process. If you are an active participant in an S corporation, your earnings aren’t subject to the net investment income tax (NIIT). (This is a 3.8% surtax on certain kinds of investment income that you must pay if your adjusted gross income exceeds a certain level.) But C corporation dividends are subject to the NIIT, if otherwise applicable, regardless of the owner’s participation level in the corporation.

Plus, if you sell S corporation stock, these proceeds won’t be subject to the NIIT if the owner is an active participant in the S corporation. But proceeds from the sale of C corporation stock are subject to this surtax.

A multifaceted decision

Many factors go into the C vs. S corporation decision, including a number of nontax considerations that aren’t covered above. Take the time to carefully study the benefits and drawbacks of each option before choosing the right structure for your company.