Should You Form an S or C Corporation?

The answer is: Do not do this unless you have consulted with an attorney and a tax professional and know exactly what you are getting yourself into. Forming an S or C Corporation makes sense only for a very small number of family child care providers.

I've previously written about why it's best to be a sole proprietor and why it usually doesn't make sense to form a partnership or Limited Liability Company (LLC).

An S or C Corporation is the most complex business entity under which to operate your child care program. When forming either of these types of corporations you must follow your state requirements which usually include: identifying corporate officers, drafting articles of incorporation and bylaws, and holding stockholders meetings. This is a lot of additional paperwork.

These corporations must pay state filing fees, annual state business fees, and higher tax preparation fees. 

The main advantage of these corporations is reduced personal liability. This means that you are no longer personally liable for the debts of the business and in a lawsuit; only your business assets would be at risk. However, you can still be sued personally if you are negligent (shaking a baby or child abuse). Incorporating is no substitute for purchasing a lot of business liability insurance coverage ($1 million per occurrence and $3 million aggregate).

It's possible to reduce your federal taxes by incorporating as an S or C Corporation. You will have to set yourself up as an employee of the corporation and pay various federal and state payroll taxes. But you can reduce your Social Security taxes by distributing some of your profit as dividends rather than as salary. There are differences in the taxes paid by an S or C Corporation. You will be better off with an S corporation if your profit is smaller.

This tax benefit comes at a price: You will owe federal and state unemployment taxes, file numerous federal and state payroll tax forms, and file quarterly estimated taxes.

However, the biggest drawback to being a corporation (other than the additional record keeping and paperwork) is you lose the ability to deduct house depreciation. This can be a major loss of a business deduction. It can be overcome but only if your profit is high enough (perhaps more than $30,000 per year).

This is only a brief summary of S and C Corporations. You should learn much more about these entities before making a decision to incorporate. 

For a detailed discussion of all the pros and cons of incorporating your business, see my Family Child Care Legal and Insurance Guide. See also my article, The Consequences of Incorporating.

This article is part of a series about business structures. See also "Should You Incorporate Your Family Child Care Business", "Should You Form a Family Child Care Partnership?" "Should You Set Up a Limited Liability Company (LLC)?" , "Should You Form an S or C Corporation?" and "Should You Set Up a Nonprofit Corporation?"

 Image credit: billeater.com

For more information see my book Family Child Care Legal and Insurance Guide.

Comments

[donyu]

Would you not have your business rent back your house space and so still get the deduction?

[Tom Copeland]

If the business rents the house from you the business can claim the rent as an expense. But you have to report the rent as rental income as an individual on Schedule E. However, you cannot claim house expenses as a deduction on Schedule E. See IRS Code Section 280A.

[Maria]

Isn't another advantage that you can be covered under workman's comp. and unemployment benefits.

[Tom Copeland]

Maria - Yes and no. Yes, because you could get unemployment as an employee of a corporation, but no, you can be covered by workers' compensation even if you are not incorporated. I don't think these two issues are a significant reason to incorporate.