Sub Chapter S Corporations

The Tax Attic with Jerry Coon — October 15, 2009

October 15, 2009 // 0 Comments

Sub Chapter S Corporations This week, I would like to continue a discussion of the various entities that are available to taxpayers who are starting a business. In the past weeks, I have written that a Schedule C or Sole Proprietorship is one option. A second option is operating as a LLC or Limited Liability Corporation. A third option is incorporating and operating as a C Corporation. A fourth option is incorporating and operating as a Sub Chapter S Corporation. This week, we will look at that fourth option. All Sub S Corporations file a Federal Form 1120S, upon which is reported the income and expenses of the business. Each of the shareholders of the Sub S Corporation receives a K-1. On the K-1 is reported the shareholder’s share of the profit or the loss of the corporation as well as items that are separately stated to the shareholders. An example of a separately stated expense item is the expense deduction should the corporation elect to completely write off the purchase of an asset. An example of a separately stated income item is the capital gain that may result from the sale of an asset. The profit or loss of the business and the separately stated items is divided by the ownership percentage of each shareholder. When the shareholders file their personal Form 1040, each of the items on the K-1 is reported as an income or expense item. In only extreme circumstances would the Sub S itself pay any tax. The shareholders pay the tax at their personal tax rates. One of the largest differences between a C Corporation and a Sub S Corporation is that the C Corporation pays tax on its profit while the shareholders pay tax on the profit of a Sub S Corporation. A further difference is the shareholders of the Sub S are then eligible to receive distributions of their share of the profit that is taxed to them. As opposed to a partnership or a Sole Proprietorship, this profit is not subject to Social Security tax. Since they have paid tax on the profit, these distributions are not considered additional taxable income. It bears repeating that these distributions and the allocated profits are not subject to Social Security […]