In this video, we cover taxability of compensation by owners as covered on the tax compliance and planning (TCP) CPA exam in a form of a CPA exam simulation.
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C and S corporations offer distinct tax advantages over partnerships, particularly regarding the treatment of Social Security and Medicare taxes and the provision of fringe benefits. These advantages can influence the choice of entity type based on the potential for tax savings.

Tax Deduction on Social Security and Medicare Taxes
Both C and S corporations can deduct the employer's contribution to Social Security and Medicare taxes (collectively known as FICA taxes) paid on behalf of their shareholder-employees. This deduction lowers the corporation's taxable income, offering a direct tax benefit. For C corporations, this reduction decreases the corporation's overall tax liability. In the case of S corporations, since profits and losses flow through to the shareholders, reducing the corporation's income effectively lowers the taxable income passed through to the owners.

Example: If a C corporation pays $100,000 in salaries to its shareholder-employees and contributes $7,650 (7.65%) as the employer's share of FICA taxes, it can deduct the total amount ($107,650) from its taxable income. This deduction directly reduces the corporation's tax liability. In an S corporation, this deduction would reduce the income passed through to shareholders, potentially lowering their individual tax liabilities.

Fringe Benefits
The tax treatment of fringe benefits further distinguishes C corporations from S corporations and partnerships. For C corporation shareholder-employees, qualifying fringe benefits are generally tax-free, not added to their taxable income. S corporation shareholders who own 2 percent or less also enjoy this benefit, making certain fringe benefits like health insurance premiums non-taxable. However, this tax-free advantage does not extend to partners in a partnership or S corporation shareholders owning more than 2 percent, for whom these benefits are typically taxable.

Example: Consider a C corporation that provides $10,000 in health insurance premiums for its shareholder-employees. This amount is deductible by the corporation and not taxable to the shareholder-employees, offering a double tax benefit. Conversely, if a partnership provides the same benefit to its partners, the amount is treated as guaranteed payment, deductible by the partnership but taxable to the partners.

These examples illustrate how C and S corporations can offer more favorable tax treatment under certain conditions, making them potentially more attractive for businesses looking to maximize tax efficiency. However, the best entity choice depends on various factors, including the business's size, income, and goals. Each business scenario requires a tailored analysis to determine the most advantageous entity type for taxation purposes.

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