By Aida Dismondy/
It is tax season. As a business attorney, it has come to my attention, listening to CPAs, that some businesses owners once having formed a company fail, for various reasons, to make a tax election. When tax season comes and they sit with their accountant or CPA to prepare the taxes, they find that no tax election was made. Tax election is the next important step after forming the company because it determines how the profits will be divided.
When forming a business the attorney working with the owner(s) should make you aware that the next step after forming the company is taxation. An attorney should coordinate with the CPA or a tax advisor about the filing of the tax elections, for when tax season comes and no election has been made, it might be usually too late to make an election.
If a corporation is formed under state law, then it has to take the next step and choose one of the two available tax choices elections: be taxed under subchapter S (also known as S-Corp), or be taxed under subchapter C (C-Corp) of the IRS code. A business owner working with a CPA or tax attorney gets to choose. If no choice of election is made then a corporation will be taxed under subchapter C, as C-Corp. A C-Corp pays its own taxes directly, and the owners pay tax on the wages. An S-Corp is a pass-through entity. The election applies to small business corporations; whereas larger corporations choose subchapter C.
If on the other hand, an LLC is formed, then a business owner gets to choose how they will be taxed; either as a partnership, an S-Corp, or a C-Corp. For this reason, it is called an LLC tax election. Each of the elections is determined by a separate set of factors and circumstances that should be discussed with the attorney and the CPA or tax advisor, both of them working in concert with each other. Ultimately, it is the CPA or the tax advisor, who will guide the owner(s) in making the determination, as experts in tax, and the work of the attorney is to draft the operating agreement accordingly.
In conclusion, when forming a company don’t stop at the formation but go through taxation election. The consequences are not just a matter of time wasted, but also a choice of control that a business owner(s) could have on taxation of their profits might not be available at the time of filing. Hence, it could result in paying money that could have been saved.