One of the most trying aspects of running a business is tax compliance. It’s probably the one thing that business owners need the most professional help with.
At the end of the day—or more precisely, the fiscal year—business owners need a competent tax pro who can prepare their return, ease their tax burden, and, above all, help them avoid unnecessary payments and audits. That’s not so challenging with S corporations, whose tax returns usually aren’t as complicated, but C corporations abide by different tax rules.
Whether you’re a certified public accountant (CPA), enrolled agent (EA), or other tax professional involved in shareholders’ tax returns, you need to keep up to date with the Internal Revenue Service (IRS) tax code in order to fully understand the ins and outs of how S and C corporations are set up, and how the taxation and dividend distribution works for each.
Double Tax Trouble
The main difference between a C and an S corporation is the way they’re taxed. An S corporation is considered a pass-through entity, in that the corporation passes corporate income, losses, deductions and credits to shareholders who then report the flow-through on their personal tax returns, under IRS tax rules.
On the flip side, a C corporation doesn’t get a tax deduction when it distributes dividends to shareholders, and shareholders can’t deduct any loss of the corporation. Thus, the C corporation pays corporate-level tax on its profits, and then the individual shareholders pay a tax on any dividends they receive. This creates a double taxation in a sense.
To avoid the double taxation, businesses will sometimes disperse money to shareholders in ways other than dividends, such as deducting personal expenses as business expenses, paying an excessive salary, or lending corporate cash. Aware of that strategy, the IRS is on the lookout for disguised dividends so these tactics could raise a red flag on returns.
Comply With Complicated C Corp Regulations
As a professional tax preparer, you need to understand how a C Corporation is formed and capitalized as well as the different tax implications that a C Corporation faces. For example, a C corporation is required by the IRS to file Form 1120 and accompanying schedules to report the business income and claim its deductions. Tax preparers must know how to properly handle and calculate dividends on a C corporation’s tax return.
Not every avoidance of double taxation is fraud. “Lending corporate cash to shareholders can be an effective way to give the shareholders use of the funds without the double-tax consequences of dividends,” according to The Tax Adviser.
There are, however, a host of factors you must consider to determine if the advance should be treated as a loan or a dividend. You need to know how to properly manage these types of transactions on corporations’ tax returns in order to keep your business clients in compliance with tax laws. Managing start-up costs, capitalization, shareholder compensation, net income for book and tax, net operating losses and dividends are all key considerations.
Learn the Facts of a C Corporation’s Life
Taxation expert Vicki Mulak, EA, CFP, explores the various phases of a C corporation’s life—from how it comes into existence to how it is maintained as a state law entity—in an audio conference for Eli Financial, “C Corporations for Dummies.” During this session Mulak focuses on return preparation issues and provides examples of common scenarios with calculations and completed tax forms.