I try to find a clear answer on a few corporate tax questions, but not
successful so far. Appreciated if anyone can explain to me.
1). Is there any CPA here close to Sacramento, California? We need a
CPA to help out with our business. Preferrably someone who had
experience with international trade, import/export, wholesale/retail
inventory businesses before.
2). Does S Corp in California pays 1.5% state tax on net income, while
an LLC pays a 1.5% state tax on gross receipts? Our business may have
large amount of gross receipts and expenses, but not necessarily big
3). What's the rule of thumb regarding whether to incorporate as an
S-corp or C-corp? For example, under how much of a net profit shall we
go with what corporate type?
4). Do foreign shareholders pay tax in the U.S. ?
5). Many say that C-corp will end up paying double tax when you start
wanting to pay out the profit from the corporation. So what's the end
of the story of a C-corp? What's the common exit strategy for an
Thank you very much in advance!
Well, I'll tackle some of them. You'd have been wiser to post this
over on misc.taxes.moderated.
> 1). Is there any CPA here close to Sacramento, California? We need a
> CPA to help out with our business. Preferrably someone who had
> experience with international trade, import/export, wholesale/retail
> inventory businesses before.
There are many CPAs and enrolled agents in the Sacramento area. Check
the phone book.
> 2). Does S Corp in California pays 1.5% state tax on net income, while
> an LLC pays a 1.5% state tax on gross receipts? Our business may have
> large amount of gross receipts and expenses, but not necessarily big
> net income.
An S corporation is subject to the California corporate franchise tax
at a reduced rate of 1.5% of net income (a C corporation pays 8.3%), or
the $800 fixed-dollar minimum, whichever is greater. An LLC pays the
$800 minimum tax PLUS a fee that is on a sliding scale based on "total
income," which is gross receipts with certain adjustments. There is no
fee if "total income" is $250,000 or less. The maximum fee is $11,790
for an LLC with "total income" greater than $5 million. Be advised
that the fee is currently being challenged in the courts as violating
the Commerce Clause of the U.S. Constitution because it is based on
total income before apportionment. A San Francisco Superior Court has
held that it is unconstitutional, and the decision will be appealed.
The FTB advises taxpayers to pay the fee and file protective claims for
refund, which it will hold pending resolution of the litigation.
An LLC can elect to be taxed as a corporation, and then make a
Subchapter S election. In that case it is subject to the S corporation
franchise tax and not to the LLC fee.
> 3). What's the rule of thumb regarding whether to incorporate as an
> S-corp or C-corp? For example, under how much of a net profit shall we
> go with what corporate type?
There is no "rule of thumb" that I know of. However, if the
corporation is expected either to have large profits (however you
define "large" for your own purposes) or to hold assets that may
appreciate in value, an S corporation will avoid the double taxation
that would result from using a C corporation. See below about getting
appreciated assets out of a C corporation.
> 4). Do foreign shareholders pay tax in the U.S. ?
Yes, non-U.S. persons pay a withholding tax on U.S.-source dividends
and interest at a rate of 30% or lower rate established by treaty.
Non-U.S. persons also pay U.S. tax on income that is effectively
connected with a U.S. trade or business, which would include the
flowthrough income from an LLC that elects to be taxed as a
partnership. An S corporation cannot have a non-U.S. person as a
> 5). Many say that C-corp will end up paying double tax when you start
> wanting to pay out the profit from the corporation. So what's the end
> of the story of a C-corp? What's the common exit strategy for an
> ordinary C-corp?
There is no general exit strategy that I know of except to pay tax on
the income twice. A C corporation's net income is taxed at the
corporate level. When it is distributed to the stockholders in the
form of dividends, it is taxed to them as ordinary income. If a C
corporation sells appreciated property, the gain is taxed at the
corporate level and again when (and if) it is distributed to the
stockholders in the form of dividends.
If a C corporation distributes appreciated property to its
stockholders, it must recognize and pay tax on the gain as if it had
sold the property at its fair market value (IRC Sec. 311(b)), and the
stockholders recognize the FMV of the property as dividend income to
the extent of the corporation's earnings and profits (IRC Sec. 316).
If there is not enough E&P to support the dividend, the distribution
reduces the stockholder's basis in the corporation's stock (thus
increasing the gain to be recognized on ultimate sale of the stock or
liquidation of the corporation). Any excess of the distribution over
the stockholder's basis is capital gain to the stockholder.
If a C corporation liquidates and distributes all of its assets to its
stockholders, it must recognize gain at the corporate level as if it
had sold the assets at FMV. In that case, the stockholders will
recognize capital gain to the extent that the FMV of the assets
distributed in liquidation exceeds their basis in the corporation's
stock. Since the 1986 repeal of the one-year liquidation rules, it is
just about impossible to get appreciated assets out of a C corporation
without paying tax on the gain twice. That fact accounts for a great
deal of the increase in use of flowthrough entities such as
partnerships, S corporations and LLCs in the last 20 years.
That being said, many personal service businesses are organized as C
corporations because (a) the C corp rules are simpler than the S rules,
(b) they can effectively zero out their net income by paying a salary
to the stockholder/employee, so there is no net income to be taxed at
the corporate level, and (c) they do not own any real estate,
inventory, or other assets that are likely to increase in value.
The choice of business entity is a decision that should always be made
with the help of qualified tax and legal professionals who have access
to all of the relevant facts and circumstances. It is not a
Katie in San Diego
The foregoing is intended for educational purposes only and does not
constitute legal or professional advice. Nothing contained herein is
intended to be used, or can be used, by any person to avoid penalties
that may be imposed under federal or any state law.