Corporate Designations For Tax Purposes

Once a business has been formally incorporated, it functions as a self-standing entity for tax reporting purposes at the end of the year. This is the main way that corporations differ from sole proprietorships or business partnerships. In a sole proprietorship, business income is reported as part of the proprietor’s (or partner’s) income. A corporation files its own tax return, reporting its income and expenses.

At tax time, a corporation must be designated as either a “C” corporation or an “S” corporation. The difference lies primarily in how corporate income is distributed to the owners, and how it is reported to the IRS.

The most common designation is “C-corp”. “C” corporations report income similarly to how an individual reports income: profits are taxable and losses are deductible. The income of the shareholders or owners is calculated as a salary expense and reported as income by the recipients. Those who are paid by the corporations then pay the appropriate income tax on that salary or dividends.

A corporation can choose to be classified as an “S-corp” by completing IRS form 2553, and income is reported differently, similar to a sole proprietorship or partnership. Profits and losses are credited directly to owners and shareholders and reported on their individual tax returns. The organization itself does not pay the income taxes on the profits. In order to make the S-corp designation, all shareholders must agree and sign form 2553.

In order to be designated as an S-corp, the business must be an eligible entity, have fewer than 100 shareholders, and can only issue one type of stock. Eligible entities include United States-based corporations and Limited Liability Companies (LLC) that have opted to be treated as corporations for tax purposes. Organizations can convert from C-corp to S-corp, and S-corps may revert to C-corps when it no longer meets the eligibility requirements.