The two most common forms of incorporation are C and S corporations. Aimed at smaller companies, S corporations protect over personal liability and allow all proceeds to “pass-through” the shareholders.
Any larger corporation is likely to join a C corporation as they protect from liability but relinquish a “pass-through” status for an unlimited number of shareholders. Note that both types require additional documentation and you must comply with all relevant regulations.
The main differences between a C Corp and an S corp are in the tax structure of the business. While there are some fundamental differences, these business structures also share some common ground. With s corporations, the tax burdens will be shifted to business partners. C-corporations, on the other hand, will pay corporate tax and individual partners will pay income tax as well, if the company pays them dividends.
What is a C corporation?
Corporations, sometimes called c corporations “to distinguish them from s corporations,” have been around since ancient times. The word comes from the Latin “corpus” or “body”.
Many refer to C corporations simply as corporations. A corporation pays taxes under Chapter C of the IRS tax code, which is where the name comes from. That means that the corporation itself is a legal entity that is responsible for its own debts and pays its own taxes.
The owners of a C corporation are called shareholders and remain protected from liability for the company’s actions. They pay their taxes on dividends received from personal shares.
The activities of the corporation, including sales, income, expenses, assets and liabilities, are legally separated from those of its shareholders.
What is an S corporation?
An S Corp is a business that has received Subchapter S designation from the IRS. Companies that meet certain requirements can apply for designation in order to avoid the double tax pitfall that C corporations encounter. S corporations are still considered separate legal entities, but their income passes through the shareholders and is taxed only at that level.
An S corporation offers shareholders protection against business liabilities.
S-corps are a subset of a corporation. first, a corporation must be formed, then s-corp status can be elected.
Both S and C corporations must file articles of incorporation with the State. To become an S corporation, all shareholders must sign and file Form its IRS. Not all companies can become an S corporation; You must meet five requirements:
- Domestic corporation.
- 100 shareholders or fewer.
- No more than one class of shares.
- Not specifically ineligible.
- Have allowed shareholders.
Some businesses, such as financial institutions and insurance companies, are specifically excluded from S corporation status. Allowable shareholders include individual and particular trusts or estates, but not partnerships, corporations, or nonresident aliens.
Taxation is often considered the most significant difference for small business owners when evaluating S corporations versus C corporations. C corporations file a tax return and pay their income taxes as a separate entity. So if the income or profits are shared among the shareholders, each of them pays the personal income tax.
This practice, known as double taxation, is a major business disadvantage. Corporations file informative tax returns, but do not pay income taxes directly. Instead, all proceeds go to shareholders, who pay income taxes. For both types, any owner or employee salary will be subject to income tax.
Both companies consist of shareholders, directors and officers: the shareholders own the company and elect the Board of Directors that deals with corporate decision-making and elect the officers who run the business on a day-to-day basis. C corporations can have any number of shareholders, each of which can be any legal person, and various classes of shares.
S corporation law limits 100 shareholders or fewer, none of whom are other corporations, partnerships, or certain types of trusts and have only one class of shares. BizFilings advises: “C corporations, therefore, provide a bit more flexibility when starting businesses if you plan to grow, expand ownership, or sell your corporation.”
A c-corp is what you have if you don’t choose s-corp status with the irs. Owners of C corporations and owners of S corporations have the same protection against lawsuits brought against the corporation. Because the activities of the corporation are separate, its responsibilities cannot be legally transferred to its shareholders.
The shareholders of the corporation cannot be sued on behalf of the corporation, nor are they personally liable for the debts they incur. This separation is sometimes called a “corporate shield,” but the shield can be pierced if an owner, board member, or executive acts outside the limits of the law or the duties and responsibilities of their office.
Shares and dividends
Taxes draw the most definitive line in the sand between bodies s and c. Shareholders of a corporation or partnership can receive dividends or shares from the corporation’s income, and they can sell their shares at a profit or loss. However, these owners have a double tax dilemma.
The corporation pays taxes on its profits and the owners also pay taxes on the dividends they receive. the owners of a corporation who work in the business, usually in executive positions, are considered employees. They must be paid a reasonable salary and must also pay taxes on this personal income.
A corporation does not pay dividends to its owners. The business files a tax return (Form 1120) showing its net profit or loss for the year. This amount is transferred to individual shareholders and their personal statements are reported, even if the owner does not receive it in the form of dividends. When the business goes through a loss, it becomes a deduction for the shareholder, up to the amount of his original investment.
The s-corp issues each shareholder a k-1 schedule, showing the amount of profit or loss allocated to that individual. shareholders must report k-1 income on their personal tax returns. This gain or loss is added to your other income and deductions.
Making the decision
The decision to choose s-corporation status for a company is an individual one. Many companies choose S status for tax reasons. However, there are other considerations. Converting from a corporation to an s- can also be tricky and complicated. For example, conversion from commercial property to s-corp must be done carefully to avoid tax problems.
If you look at the tax differences between the two entities, consider whether you want to pay the tax personally or whether you want the corporation to pay the tax. If you work as an employee of the corporation, you must take a reasonable salary, so you will still have to pay taxes.
If you are considering a corporation election, get qualified opinions on all taxes and other issues and get help filing for elections. Discuss any decisions regarding your business status with your tax professional and attorney before making a decision.
The balance does not provide tax, investment, or financial advice or services. The information is presented without regard to the investment objectives, risk tolerance, or financial circumstances of any specific investor and may not be suitable for all investors. Past performance is not indicative of future results. Investing carries risks, including the possible loss of capital.