Mark Pierce, Esq.
When you start a business, your choice of business entity is an incredibly important decision. This decision will have a great impact on you, your operation, your investors, and potentially your employees. It is therefore important that you make the right decision.
C-corporations are the most common type of business entity in the United States. C-Corporations are separate legal entities set up under state law to protect its owners' assets from liabilities arising from business activities (limited liability).
An S-corporation is a business entity that is more attractive to small business owners because it offers certain tax advantages. An S-corporation can be created after you have incorporated as a traditional C-corporation or limited liability company (LLC) by filing documents with your state and the IRS.
How C-Corporations and S-Corporations Compare
C-corporations and S-corporations are similar in that they both:
- Provide their directors, officers, shareholders, and employees with limited liability protection;
- Can attract investors by selling shares of stock in the corporation; and
- Can enjoy perpetual existence as they can continue to exist even if the owner leaves or passes away.
However, there are a number of significant differences between C-corporations and S-corporations. To start with, a C-corporation is a distinct type of business structure that can only be formed by filing articles of incorporation and other necessary documents with the secretary of state, electing corporate directors, issuing stock, and drafting corporate bylaws.
On the other hand, rather than a distinct type of corporate business structure, an S-corporation is a federal tax status that can be elected after forming a traditional C-corporation or LLC. Corporations that meet certain requirements can elect S-corporation status by filing Form 2553 with the IRS.
Other differences between c-corporations and s-corporation relate to the following:
- Ownership; and
One of the biggest differences between a C-corporation and an S-corporation relates to how the two are taxed. C-corporations are subject to what is referred to as double taxation. Income is earned by the corporation and the corporation itself must pay taxes on that income. Then profits are distributed to the corporation's shareholders as dividends, where it is taxed again as personal income.
In essence, the income earned by the C-corporation is taxed twice: once at the corporate level and then again at the personal level. Hence, the term double taxation.
On the other hand, an S-corporation is considered a pass-through entity for tax purposes because the income passes through to the shareholders or owners and is taxed only at the personal level.
The S-corporation must still report the income, but taxes are only payable at the shareholder or personal level. Thus, with an S-corporation, there is no double taxation.
Another difference between a C-corporation and an S-corporation has to do with the legal requirements for ownership. An S-corporation cannot have more than 100 shareholders in contrast to a C-corporation which can have an unlimited number of shareholders.
Furthermore, there are restrictions on who can own shares in an S-corporation. U.S. citizens, permanent residents, and some qualified trusts can own shares in an S-corporation, but nonresident aliens and business entities, such as corporations and LLCs, cannot own stock in an S-corporation.
There are no restrictions whatsoever on who can own interest in the corporation if it is a C-Corporation.
Classes of Stock
An S-corporation can only have one class of stock whereas a C-corporation can have multiple classes of stock conferring different rights and obligations upon the shareholder.
Is a C-Corporation or S-Corporation Better for You?
For most small businesses, an S-corporation is the better option. Regardless of which business entity you choose, forming a corporation can be complicated. An experienced business law attorney can help you select and form the business entity that is right for you.
If you have more questions about the differences between a C-corporation and an S-corporation, or how to form one or the other, contact us to arrange a consult with an experienced business law attorney.