So, you started your business and established an LLC or a corporation. But you are not sure of the tax status. You decide to ask an important question: How to Tell if a Company is an S Corp or C Corp?
Examining your entity tax status is critical. S Corps and C Corps are both types of corporations, but they have different tax treatments.
In this guide, we will show you how to determine the type of corporation and what that means from a compliance standpoint. Let’s dive in.
Some background
A C Corp is taxed as a separate entity from its owners, paying taxes on its profits at the corporate tax rate. Shareholders of a C Corp are taxed on dividends they receive from the company.
On the other hand, an S Corp is a pass-through entity, meaning that the profits and losses of the company are passed through to the owners’ personal tax returns. S Corps do not pay federal income tax at the corporate level, but shareholders must report their share of the company’s income or loss on their personal tax returns.
How to Tell if a Company is an S Corp or C Corp
Understanding what type of entity you have is very important. This determines the type of tax deductions you’re allowed to take and any required filings or forms that need to be included at the personal level.
There are various ways you can determine if a company file is an S Corp. or C Corp. So will list the top few. But most importantly, if you set up a new LLC or corporation, the default classification rules will be essential for you to understand.
In addition, make sure you hire a CPA with experience dealing with the different types of entities. That way, you can get the filings correct and accurate. And make sure that you don’t have any delinquent tax returns.
IRS EIN letter and Other Correspondence
When you set up your LLC or corporation, did you get an EIN from the IRS? You should have.
It usually takes a couple of weeks for this letter confirming the EIN to arrive. You might have to dig this up because it may be in one of your files. It is basically a one-page letter that spells out the EIN as well as a few IRS formalities.
But take a close look at the letter. In the top middle, the IRS will tell you what form they expect you to file. Again form 1120 is for a C corporation while 1120 S is for an S corporation.
What tax return does the business file?
There are a few different legal structures that you can do that, including LLCs and corporations. But thanks to IRS flexibility, these legal structures can be taxed differently. These will also file different tax returns, depending on the tax classification.
Specifically, a C corporation will file form 1120. However, an S corporation will file form 1120-S.
So you first want to look at the prior year’s tax return and see on the top left what form it is filing. This will give you some good insight.
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In addition, you may have tried to file an extension for one of the forms. For example, you may have thought that you had an S Corp., so you filed an S Corp. extension for a given tax year. Was it accepted or rejected? If accepted, that gives you a pretty good idea that the classification that you believed you had is consistent with the IRS classification.
But if it’s rejected, the IRS may disagree with your filing status or might have yet to receive any paperwork relating to your change in status. Do you want to follow up with them to clarify the issue?
Default Classifications
Ensure you understand the initial tax clarify classifications for the LLC or corporation. This is your starting point.
If you have an LLC, the IRS will have default classifications. None of the default classifications will be S or C corporations.
However, LLCs can elect to be taxed differently. If the LLC wants to be a C corporation, it will file form 88,32. If the LLC wants to be an S corporation, it’ll file form 2553.
The critical point to note is that an LLC will never start out being taxed as an S corporation or C corporation. It must be an election that the LLC members have made to change the status.
But what if you started with an actual corporation? What is the default classification?
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If you set up an actual corporation at the state level, then the LLC the corporation will begin being taxed as a C corporation. This is the default classification for the IRS.
The corporate shareholders must file form 2553 to be elected to be taxed as an S corporation. This is one of the common problems in that many people set up corporations and assume they are by default. S corporations. This is simply not true.
Final thoughts
In summary, you are able to determine whether a business is an S corporation or a C corporation by reviewing its formation documents, income tax filings, ownership/shareholder structure, and overall tax treatment. It’s vital to know the company’s tax status as it will impact its tax bill and any shareholder liability.