Corporate losses remain in a C corporation, and cannot be deducted by the shareholders, as they can be deducted by partners, shareholders, and members in the case of partnerships, S corporations, and LLCs. Deductions must be postponed until the corporation has income, and may be permanently lost.

An S corporation is a corporation that has made an election with the IRS to be treated for tax purposes as a “pass-through entity.” This means that corporate profits and losses are passed through to the shareholders (owners) who report them on their own personal tax returns and pay the tax at the individual level. The corporation pays no federal income tax at the corporate level. S corporations are not subject to the double taxation C corporations encounter.

For federal tax purposes, it is often best for a start-up company to be an S-corporation rather than a C-corporation. Starting as an S-corporation rather than a regular C-corporation may be wise for several reasons:

• Income from an S-corporation is taxed at only one level rather than two – your total tax bill will likely be less.
• If your business operates at a loss the first year, you can pass that loss through to your personal income tax return,
  using it to offset income that you (and your spouse, if you’re married) may have from other sources.
• Interest you incur to buy S-corporation stock is potentially deductible as an investment interest expense.
• When you sell your S-corporation, your taxable gain on the sale of the business can be less than if you operated
  the business as a regular corporation.

Your decision to be an S-corporation isn’t permanent. If you later find there are tax advantages to being a regular corporation,
you can easily drop your S-corporation status.

An important issue to consider when deciding the structure of your business is self-employment tax. Self-employment (SE) tax is a 15.3% tax on income. This rate, 15.3%, is a total of 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

The SE tax rate for business owners is 15.3% tax of the first $94,200 of income and 2.9% of everything over $94,200.

Normally these taxes are withheld by your employer. However, if you are self employed, it is your responsibility to pay them yourself.

S corporations have a significant advantage when it comes to the payment of SE taxes. In an S corporation, only the salary actually paid out an owner/employee as compensation for services is subject to SE tax. Any money left in the business for reinvestment or distributed to the shareholder as a dividend is not subject to payroll taxes…and not subject to self-employment tax.

Owners of sole proprietorships, partnerships and LLCs however, pay SE tax on their respective share of profits rather than salary. (Certain types of LLC income, however, are not subject to self-employment tax. For example, rentals from real estate and capital gains are not considered to be self-employment income, so real estate LLCs often need not be concerned with self-employment tax.)

Here’s an example: Say, this year, you have net income of $90,000 and pay yourself $60,000 in salary, leaving $30,000 in the business to pay for equipment. As a sole proprietor, you would pay self-employment tax on the full $90,000 ($90,000 x 15.3% = $13,770). But as an S corporation, you would only owe self-employment tax on the $60,000 in salary ($60,000 x 15.3% = $9,180), resulting in a savings of $4,590.