Common Misconceptions about S-Corp and C-Corp Tax Designations

One of the most critical decisions an entrepreneur makes in the early days of a new venture is related to business formation and taxation. Selecting the right business entity is essential to a company’s successful future and impacts how an organization is taxed. Determining the correct tax designation is equally as important as properly organizing a business’s structure because this designation directly affects how a company’s profits or losses are distributed. Learn more about some of the common misconceptions regarding S-corp and C-corp tax designations and how a business attorney from the Dallas law firm of Ritter Spencer Cheng PLLC can help your business thrive.

Misconception #1: S-Corps and C-Corps are business entities

There is no such thing as a business entity known as a C-corporation or an S-corporation, but different business entities can select either C-corp or S-corp status in relation to their taxes. For example, many businesses establish themselves as a limited liability company, or LLC, because this business entity enjoys more flexibility when selecting S-corp or C-corp status. These designations are organized by the Internal Revenue Service and result in various deductions or liability protections depending on the business. Although tax designations and business entities seem similar, individuals, entrepreneurs, and companies must do their research to ensure they select the best business structure and tax designation for their organization’s unique circumstances.  

Misconception #2: A certain tax designation is best for all businesses

While an S-corp or C-corp status may have certain benefits that are more helpful in some industries, there is no single tax designation that is universally ideal for all companies. For example, some companies may favor S-corp designations because they are considered “pass-through” entities, and there is a 2017 income deduction that “pass-through” entities are entitled to. While this is appealing for some companies, others may be more interested in C-corp status due to the liability benefits in the event of failure. Each business should work with a commercial litigation attorney who can recommend the best tax designation for each company’s financial and structural situation. 

Misconception #3: There are no significant differences between a C-Corp or S-Corp designation

Although C-corp and S-corp tax designations have several similarities, they differ significantly when it comes to formation and taxation. All corporations begin with the C-corp tax designation when they are formed; however, they can file certain forms at both the federal and state levels to be converted to an S-corp. Generally, in a company with a C-corp designation, profits are taxed and reported on a corporate tax return, and then they are taxed again on personal tax returns once after-tax profits are distributed to shareholders as dividends. Some companies may try to avoid this repeated taxation by designating their business as an S-corp, which is treated more like a sole proprietorship or partnership. In an S-corp designation, any profits or losses are passed on to shareholders and taxed only on their personal tax returns. 

Each tax designation has its own advantages and disadvantages, so it is essential for business owners to research and talk with experts to find the best designation for their specific company. The experienced business attorneys at Dallas law firm Ritter Spencer Cheng PLLC can help any business determine the best entity and tax designation for their unique situation. Contact our team of commercial litigation attorneys today, and set your business up for success.