When a corporation is formed and/or does business in the U.S., it will be taxed according to either subchapter C or subchapter S of subtitle A of the Internal Revenue Code (hence the terms ‘C’ and ‘S’ corporation.)

The default tax classification of every U.S. corporation is that of a C corporation. The C corporation tax classification is not widely used, since it is subject to double taxation. Double taxation means that the corporation is taxed annually on its corporate profits, and then again when profits are distributed to its stockholders. C corporations must annually file the IRS Form 1120 income tax return whether or not they have income or conduct business (click for IRS form 1120 instructions.)

In order to avoid double taxation, most corporations choose the S corporation tax classification by filing IRS Form 2553 (click for IRS Form 2553 instructions). S corporations do not pay tax at the corporate level. Rather, each stockholder is individually responsible to annually pay his share of the corporation’s gain or loss, whether or not profits are distributed (a common misconception is that profits are not taxed unless and until they are distributed to the stockholders). Therefore, corporate profits are only taxed once. Although the corporation does not in and of itself pay any tax, it must still annually file IRS form 1120S whether or not it has income (click for IRS Form 1120S instructions). Because no tax is due with the filing of the form, this form is called an ‘informational tax return’. An 1120S schedule K-1 is then sent to the IRS and each stockholder, reflecting their individual share of the tax on company profits.

In order for a corporation to qualify for S corporation tax status, it must meet certain criteria. Such criteria include:

• The corporation must have no more than 100 shareholders.
• All shareholders must be U.S. citizens or a U.S. resident alien.
• All shareholders must be an individual, an estate, an exempt organization described in section 401(a) or 501(c)(3) of the Internal Revenue Code (IRC), a trust described in section 1361(c)(2)(A) of the IRC, or a disregarded entity that is owned by an individual (such as a single member LLC).
• Only one class of stock is allowed.
• Generally, the corporation’s fiscal/tax year must be from January 1^st to December 31^st (a.k.a. a ‘calendar year’).

 LLCs Can Elect C or S Corporate Tax Treatment

 It is important to note that an LLC may elect to be taxed as a C corporation by filing IRS Form 8832 and then (if it desires) it may further elect S corporation tax treatment via form 2553. Because an LLC is generally easier to operate than a corporation and also provides superior asset protection, it is almost always preferable to form an LLC that elects C or S corporation tax treatment over an actual C or S corporation (the exception being if the company plans to be publicly traded.)

Related Links

• Can I use my asset protection program to reduce or eliminate self-employment tax?
• What are the tax consequences of various trust or company structures?
• What is double taxation?
• What is pass-through taxation (a.k.a. single taxation)?
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