Accounting Information for S Corporations
Long before you produce your first widget or design your first couture gown, you must decide what type of business structure will best address your tax needs. While you do not need to set up an S corporation immediately, it is a common progression from a C corporation designation and a wise decision under certain circumstances. The attributes of both types of incorporation are similar, but certain key accounting characteristics are noteworthy.
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Federal Taxation
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While a C corporation acts as an individual entity for the purpose of taxation, partnerships, sole proprietorships and S corporations pass along profits or losses directly to the owners. The owners are responsible for reporting the income and paying applicable taxes. The corporation pays the taxes for a C corporation. The owners only pay taxes on the dividends actually paid out. Additionally, unlike C corporations, S corporation owners can carry forward any losses to offset future income for tax purposes. Discuss your tax situation with an accountant to determine which business structure will benefit you the most in the long run.
Owners
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While a sole proprietorship or partnership would feature owners' equity and owners' draws on the balance sheet, C and S corporation spreadsheets feature shareholder and dividend information. A sole proprietorship or a partnership changes each time a new owner is added to the company, but a corporation is designed to account for the evolution of the company to include a varying number of owners without requiring the formation of a new company. If you intend to issue stock or take on additional owners over time, you will likely want to incorporate as either a C or S Corp.
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Cash or Accrual
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An S corporation has the option of using either the cash basis or the accrual basis of accounting, depending on the type of business it is in. Cash basis may be used if the company does not have an inventory; however, if it does keep an inventory, it must use accrual basis accounting. Cash basis records the revenues as the money is received. Accrual basis accounting requires the bookkeeper to record the income as it is earned.
Business Limitations
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Certain businesses cannot incorporate as an S corporation. Among those businesses are banks, certain insurance companies and certain affiliate groups of corporations. A S corporation has no choice but to use a Dec.31 fiscal year end. As a C corporation, you can choose when to end your year. This means if you start as a C corporation and decide later to convert to an S corporation, you must change your year-ending date.
This type of corporation limits the deduction that can be taken on fringe benefits paid on behalf of a stockholder holding more than 2 percent of the corporate stock. In other words, an S corporation may not be for you if your company is small and stockholders work for the company. You may lose out on value tax deductions.
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