If incorporating as an LLC is not right for your business, how do you decided between the two types of incorporation when it comes to life insurance business planning? Before discussing such topics as using business dollars to pay for life insurance premiums, it’s important to decide whether you should incorporate as an S-Corp or a C-Corp.
S Corp taxation
If a corporation is taxed as an “S” it means it has decided to be taxed under Subchapter S of the IRS Code. S Corps do not, in general, pay federal taxes at the corporate level. Instead, items of income and loss are generally passed through to shareholders based on their ownership in the corporation. Shareholders ares then responsible for paying taxes accordingly on their personal tax returns. This is similar to partnership taxation, except that shareholders are given some liability protection.
S Corps have several requirements which can assist the producer in determining whether the client is an S or a C Corp. An S Corp must have no more than 100 shareholders and only one class of stock. Most small, family business corporations are structured as S Corps.
C Corp taxation
A company that chooses to be taxed as a C Corp has some significant differences from the Subchapter S. The most significant difference is that C Corps are taxed separately from the owners. Taxes are paid at the corporate level, but if dividends are distributed, they are considered personal income to the recipient and thus subject to personal income taxation.
With a C Corp, it is possible for the same dollars to effectively be taxed twice, once at the corporate level and once at the personal level. A C Corp files an 1120 form for tax purposes.
S Corps vs. C Corps
Both S and C Corps are established and regulated under the same rules. Both structures require corporate documents to be filed with the state of incorporation, and both offer some liability protection for their shareholders.
Because both structures are filed as formal corporations with a state, they have to follow the bylaws set out, including but not limited to holding formal meetings and paying annual registration fees.
Here is look at how a few planning strategies can be better suited to one type of structure versus the other:
Key person insurance
Company-owned life insurance on a key person, where the company is owner and beneficiary is treated the same way for both S and C Corps. It will be an expense for both corporate structures. The company is owner, beneficiary and pays the premiums. Life insurance premiums paid by the corporation are not deductible.
162 bonus plan
With this plan, life insurance premiums are paid by the company with the policy owned by the executive. This strategy can be used to reward key executives, supplement retirement income, fund estate liquidity and income replacement needs, as well as help fund a buy-sell agreement.
The 162 strategy can be used in both S and C Corps. The premium paid by the corporation is treated as a bonus and is included in the executive’s W-2. The corporation takes a deduction for the premium payment.
While a 162 bonus plan is possible with either structure, it will likely not be as tax-efficient for the owner of an S Corp as for a C Corp owner.
Because an S Corp is a pass-through entity, there is no tax paid at the corporate level. The income generated by the S Corp will be taxed to the owners whether or not it is distributed.
If the 162 bonus plan is used to benefit the owner/employee, the bonus amount is subject to payroll taxes, including Social Security and Medicare tax. Distributions of previously taxed S Corp earnings are not subject to further taxation when distributed to the S Corp shareholder. S Corp distributions are also not subject to Social Security or Medicare tax. Therefore, a better strategy may be to pay the life insurance premiums as an S Corp distribution rather than as a taxable bonus.
In contrast, a C Corp files a separate return and pays taxes. With a separate tax return being filed by a C Corp, executives’ salaries are deducted as an expense, so the bonus can reduce the C Corp’s taxes due which may be a good selling point for an owner of a C Corp.
In order to maximize the most efficient and suitable type of corporation for your needs as a business owner, it is critical to use a competent tax attorney, accountant and financial adviser.