S Corp vs C Corp: The following is a discussion of the differences and similarities between C-Corporations and S-Corporations with a look at the structure and tax implications of each.
For many business owners, a corporation makes sense as the best type of business entity to form in terms of its limited liability and its durability when growing a large company. When filing a corporation, the corporation will be designated as either a “C-Corporation” or a “S-Corporation,” each representing a different subchapter of the tax code.
When a new corporation has its Articles of Incorporation filed with the Secretary of State, it will be designated a C-Corporation (or “C-Corp”) and it will remain that way until the founder files specifically for status as an S-Corporation (or “S-Corp”).
Limited Liability & Organizational Structure
Each of these types of business entity ensures limited liability for its shareholders, which is commonly the primary reason why individuals in a company choose to incorporate. The corporation also represents a fairly straightforward business structure in that it exists its own separate legal entity that has shareholders as its owners and a board of directors managing the corporation’s high-level affairs. The elected officers generally manage the corporation on a day-to-day basis.
Taxation for Corporations
The key difference between S-Corps and C-Corps are their respective tax treatments. With the filing of a one-page document known as an “S election,” (IRS Form 2553) with the IRS, the S-Corp is taxed in a manner similar to a Limited Liability Company (LLC) or a partnership. This election of “S” status is not limited to newly formed corporations, but instead, a prior-existing C-Corp may elect to convert into an S-Corp. One of the more important considerations in converting a C-Corp into an S-Corp involves the imposition of capital gains tax on the transaction involved.
A C-Corp has its income taxed twice (often referred to as “double taxation”), meaning that tax is initially paid on the corporation’s net income. Shareholders are also required to pay tax on the amount received in any distributions from the corporation. Conversely, a S-Corp is only taxed when shareholders receive a distribution, representing a single instance of taxation occurring at the shareholder level rather than the corporate level.
To form an S-Corp, there is a requirement that the corporation only have a maximum of 100 shareholders. Moreover, only U.S. citizens and resident aliens are entitled to be shareholders and shareholders must generally be individuals, rather than other companies (such as another corporation or a partnership). If the S-Corp’s stock is divided into multiple classes with different rights attached to each class, the only difference in rights allowed are voting rights.
Choosing Your Corporate Status
While there are tax benefits to operating as an S-Corp, the S status involves more complex accounting rules. However, S-Corps may still make sense for a small business because of their ability to allow shareholders to avoid double taxation, both on net income and the proceeds of a sale, as well as potential savings on payroll taxes.
Ultimately, the correct corporate status for your company will depend primarily on the number of shareholders involved, the size of the business, and your willingness to work with legal and accounting professionals to achieve the outcome that’s best for you.
ODGERS LAW GROUP specializes in business formation and the development of strategic business plans aimed to help maximize protection and reduce tax liabilities. To learn more about business law or to schedule your free consultation with Mr. Odgers, contact us by e-mail, call us at (858) 869-1114, or schedule your appointment online here.