Forming a corporation creates a separate legal entity with its own legal identity—its own name, its own purpose, and its own responsibility to pay federal and state taxes.
A corporation is also liable for its own actions. Because of this, the corporation's shareholders enjoy limited liability for corporate debts and liabilities.
The shareholders’ liability is limited to the money they invested in the corporation.In other words, if a lawsuit is filed against the business, only the corporation’s assets can be lost, not its shareholders’ personal assets.
Types of Corporations
Corporations are distinguished for tax purposes, as C-corporations—named for Subchapter C of the Internal Revenue Code—and S-corporations, named for Subchapter S. C-corporations are the most standard type of a corporation, while S-corporations are entities that begin as C-corporations but later elect S-corporation status.
A C-corporation is a regular for-profit corporation, taxed under normal corporate income tax rules. The C-corporation files its own tax return (IRS Form 1120) and pays its own income taxes on the profits kept in the company. A C-corporation is taxed as a separate entity, at the corporate tax rate, then again at the individual tax rate if profits are distributed to its shareholders as dividends.
For some, the biggest drawback of utilizing a C-corporation to do business is that its income may be taxed twice. This generally happens at the end of the corporation’s fiscal year. If the corporation earns a profit, it pays a tax on the gain. If it then decides to pay a dividend from any after-tax profits to its shareholders, the shareholders are taxed once again. This is referred to as double taxation.
However, through proper planning, the specter of double taxation can be minimized. What's more, a C-corporation can avoid double taxation altogether by filing IRS Form 2553 to elect S-corporation status and to not be treated as a distinct entity for tax purposes.
An S-corporation is a hybrid form of business that is treated as a partnership for tax purposes and a corporation for other purposes. The S-corporation requires the filing of IRS Form 2553 by the 15th day of the third month of its tax year for the pass-through tax election to become effective.
When a corporation elects S-corporation status, it is strictly a tax adjustment, not a legal status adjustment. Though the S-corporation will be taxed differently, it retains the same abilities and obligations of a standard C-corporation.
S-corporations enjoy pass-through taxation. This means corporate income passes through to the corporation's shareholders where each reports his or her portion of the corporation's profits and losses on their individual tax return. The S-corporation is not taxed at the corporate level. Thus, there is no double taxation.
S-corporations are much like Limited Liability Companies (LLCs) but must meet strict IRS guidelines. In return, they avoid the double-taxation that plagues C-corporations. However, S-corporations, (actually, corporations in general) have a key tax advantage over LLCs that involves the applicability of self-employment taxes.
Income distributed to members of an LLC who are actively engaged in the business is subject to self-employment tax. On the other hand, S-corporation shareholders may be able to treat a certain amount of income as salary, subject to self-employment tax, and the balance as a corporate dividend, subject to income tax but not the additional self-employment tax. This difference can significantly affect the dollars you will have left in your pocket.
The Annual Franchise Tax in Texas
Unlike most other states, that tax the income generated by corporations formed or doing business within their borders, Texas does not. Instead, Texas requires corporations to pay an annual Franchise Tax simply for the privilege of doing business in the state.
This Franchise Tax must be paid annually to the Texas Comptroller of Public Accounts (CPA) between January 1 and May 15th, along with a Public Information Report (Form 05-102) that lists the names and addresses of the Corporation’s directors.
Your corporation may be exempt from having to pay the annual Franchise Tax if its total gross revenue was less than $1,130,000. However, you will still be required to file a No Tax Due Report (Form 05-163). For more detailed information regarding the annual Franchise tax in Texas, consult with an experienced Texas business law attorney.
Why Work with an Experienced Texas Business Law Attorney
Corporate taxation is not at all that difficult or time-consuming to get right, especially with the help of an experienced business law attorney who can assist you with handling the corporate filings and preparing your corporate tax return.
You have already spent the extra money to enjoy the limited liability protection that a corporation provides. It only makes sense to spend a little more money to ensure that you comply with its tax requirements as well as the corporate maintenance requirements needed to keep that protection.
To consult with an experienced Texas business law attorney, call our law firm today to arrange a free no-obligation consultation.