When starting a business, one of the reasons taxpayers choose to create a C corporation over other business forms is because the Internal Revenue Service treats the business as a separate taxpayer distinct from its shareholders. This tax treatment applies to all C corporations, regardless of whether only one sole shareholder exists or there are millions.
Initial Corporate Contribution
When you initially form the corporation, you can capitalize it with personal property and cash in exchange for all outstanding stock. Although you are the sole shareholder, this expenditure is not deductible and is subject to the same tax treatment as purchases of stocks. Rather than claim a deduction for your initial capitalization of the corporation, the amount represents your tax basis in the stock. If you sell the shares, you will calculate your taxable gain as the proceeds that exceed your tax basis.
Separate Corporate Return
Since the corporation is a separate taxpayer, you or another officer of the company must prepare a corporate tax return each year on Form 1120 or 1120A. You can't claim an expenditure of the corporation on your own return; however, you can report the expenditure on the corporate return. Corporations are eligible to claim a deduction for all expenses that are ordinary and necessary, and relate solely to the corporation’s business operations. This can include rental payments for office or warehouse space, utility fees, employee salaries, and the cost of purchasing supplies.
Shareholder Return Implications
Although you don’t report corporate expenditures on your return, as the sole shareholder, you will indirectly receive the tax benefit of all corporate deductions when you take a distribution of earnings. For example, assume the corporation reports $100,000 of revenue and $60,000 of deductible expenditures resulting in net income of $40,000. Because you have complete control over the corporation, you can take a distribution or dividend from net income. You will have to report any distribution you take on your personal tax return. However, the amount always reflects the deductions of the corporation, because the IRS won't require you to report $100,000 of taxable income if you take the $40,000 distribution.
Other Entity Structures
There are alternative business structures that allow a sole owner to report all business expenditures on their personal tax return. This is also effective for eliminating the double taxation that is inherent in C corporations. A limited liability company, for example, provides the same personal asset protection as a corporation. But for tax purposes, the IRS allows you to report all earnings and deductions of the business as a sole proprietor. Sole proprietors separately report the financial activity of a business on Schedule C, but include the net income with the other sources of earnings they report on a 1040.
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