If you’re trying to set up a business to hold your real estate investments, all the jargon and legal mumbo jumbo can be confusing. For instance, the internet is probably telling you to decide if you want your business to be an “S” corporation” or a “C” corporation,” but you don’t even know the difference between an S Corp and a C Corp. So how are you supposed to decide? Don’t worry—I’ve got your back. Think of this article as your starter guide to deciding how your business should be structured and taxed. Before you can choose between an S Corp and a C Corp, you need to understand the basics of how businesses are classified. There are two different levels of classification: Legal structure Tax status First, you’ll need to choose the type of legal structure you want your business to have (corporation vs. LLC), and then you’ll select how you want to be taxed (S Corp vs. C Corp). First Level of Business Classification — Legal Structure State laws will control the process of forming a corporation or LLC. When you start a business, you’ll need to decide if you want to be a corporation or an LLC, which controls your business’s legal structure and has nothing to do with how it will be taxed. Corporation A corporation is a business entity that is legally considered to be entirely separate from its owners. Real estate corporations can be held liable for corporate actions and earn profits that are considered the business’s income and not the owners. Generally, corporations are: Owned by shareholders, who possess freely-transferable “shares” of the business Managed by a board of directors and officers Subject to strict record-keeping requirements and corporate formalities Limited Liability Company Like corporations, a Limited Liability Company (LLC) is also a separate legal entity from its owners. However, real estate LLCs provide more flexibility in management options and fewer record-keeping requirements. LLCs are: Owned by members, who possess “membership interests” with typically strict limitations on transferability Managed by the members (usually) or by a non-member manager Subject to limited record-keeping requirements and corporate formalities Side note: If you’re starting your business to hold multiple real estate investments, you may want to consider forming a series LLC, which allows you to hold your investments in separate “series” within the same LLC for maximum asset protection and convenience. Should Your Business Be An LLC Or A Corporation? Whether an LLC or corporation is a better structure for your business depends on various factors, including your goals for your business and your desired management structure. You should consult with an experienced business attorney when deciding which type of entity is best suited to your ambitions. Second Level of Business Classification — Tax Status Once you’ve decided on a legal structure for your business, you’ll also have to choose how you want to be taxed: S corp or C Corp? Both corporations and LLCs have the opportunity to choose between the two tax statuses. C Corporation The IRS acknowledges C Corps as distinct taxpaying entities. This means that if you go with a C Corp, your business’ profits will be taxed like “personal income” of the corporation. You’ll have to file a tax return for the company each year. Any portion of the profits distributed to the owners will be taxed again as their personal income. S Corporation S Corps are what is known as “pass-through” entities. This means that S Corps themselves don’t pay taxes. Instead, the company’s profits (or losses) are passed through to its owners for tax purposes. Each owner will include their portion of the company’s profits and losses on their personal tax returns and pay taxes based on their individual tax bracket. Additionally, S Corp distributions are not subject to Social Security taxes as long as you’re paying yourself a reasonable salary. Because of the advantages offered by S Corp taxes, many real estate investors elect this tax status for their businesses. Default Tax Statuses The IRS will assign a default tax status to your corporation or LLC if you don’t tell them that you want them to do something different. What your default tax status is depends on the type of entity you formed and how many owners there are. Default Tax Status For Corporations When you form a corporation, the IRS will automatically consider you to be a C Corp. Default Tax Status For LLCs When it comes to taxes, there’s no such thing as an LLC. By default, single-member LLCs will be treated as sole proprietorships, and LLCs with two members or more will be treated as partnerships. The LLC will be viewed as a “disregarded entity” and will not be taxed. How To Change Your Default Tax Status If you form a corporation and decide you’d prefer to be taxed as an S Corp than a C Corp, you can file Form 2553 with the IRS to change your corporation’s tax status. Similarly, LLCs can file Form 8832 and choose to be taxed like an S Corp or C Corp. S Corp Versus C Corp So, you can elect to be taxed as either an S or C corporation. Why would you choose one over the other? In short: If you are going to bleed your company dry, an S Corp may be better. If you are building a business and need to leave funds with the company to grow the business, a C Corp may be better. However, you should always talk to your tax advisor and your attorney to figure out which is best for your particular circumstances and goals.. When An S Corporation Is Better An S corporation works really well when you’re taking all the money out because there’s only one tax level—at the shareholder level. That means the owner is the only one that’s taxed—the company is not taxed. This is the best option if you’re going to take all the money out of the business. When A C Corporation Is Better There are also many advantages to going the C corp route, including a 21% corporate tax rate. In a state like Texas or Wyoming or Nevada (where there aren’t corporate taxes), you’re getting a 21% flat rate on all the money you leave in the company. The more you can keep in a C corp, the better off you will be because of the 21% tax rate. In a C Corp, the corporation is taxed, and then, when money is distributed, it’s taxed again at the shareholder level. If you’re taking money out of the company, it probably should be as salary, because otherwise, you’re going to be double taxed. What’s Next? After you decide how to tax your business (S Corporation or a C Corporation), you need to pay yourself a reasonable salary. You’re going to want a bookkeeper. You’re an independent contractor employed by your business now, but you’ll have to correctly handle the withholdings. This includes filing the payroll tax reports. An experienced lawyer can help you get through this process and make sure you set everything up properly. Interested in learning more? Check out our articles Using Your S Corp: Payroll Taxes and Using Your C Corporation’s Tax Brackets To Reduce Your Tax Burden.