Corporate Tax is a critical issue when you’re forming your new company. You don’t want to pay corporate taxes if you don’t have to. The corporate tax rate at the federal level is about 35%, while at the state level it’s about 9%. You get a credit for the state tax against the federal tax, but you’re still paying about 40% in taxes. Then, when you pay out a dividend, the individual pays his own level of taxes again which can be as much as 40%. So, paying 40% once and 40% on that 60% that’s leftover is a huge cost to a young company. Normally, you pay out all of the earnings of a corporation at the end of its fiscal year so there are no corporate taxes to pay on a start-up (if there are earnings). Often there isn’t enough money to worry about. But, whatever is leftover, you’ll pay out as a bonus to the people who have been working for the company, or you’ll figure out a way to spend it before the end of the fiscal year. You can file what’s called an S-Election, Form 2553, with the IRS. This allows you to basically avoid corporate taxes except at the state level. The good thing about the S-Election is that it converts it to just one level of taxation at the personal level. The detriment to an S-Election is that it puts some limitations on other benefits that you can have from a corporation. One of those key benefits is if you’re an initial investor in the company and you hold your stock for more than five years, you get a significant capital gains tax break when you sell the stock. With an S-Election, there are many rules. For this reason, you have to continuously work with your accountant to make sure you still qualify. Some of the disqualifying factors include if you are a non-US taxpayer, If you are a shareholder, or if you have entities holding stock. Often when we form a corporation, even if you’d like to have an S-Election, we won’t file it because we know that those rules are going to eventually be broken. Venture capitalists and funds like to see a C-corporation for tax reasons.
No comments yet