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 get the decision right in the first place.
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 a c-corporation and an s corporation. To start with, a c-corporation is a distinct type of business structure that can only be formed by, amongst other things, 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 has to pay taxes on that income. Then profits are distributed to the corporation's shareholders as dividends, where it is taxed again as personal income.
So, in essence, the income earned by the c-corporation is taxed twice - once at the corporate level and then again at the personal level. Thus, 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 can only have up to 100 shareholders. Whereas a c-corporation can have an unlimited number of shareholders.
Furthermore, there are restrictions on who can own shares in an s-corporation.
While individuals, who are U.S. citizens or permanent residents, and some qualified trusts can own shares in an s-corporation, nonresident aliens and other business entities, such as corporations and LLCs, cannot own stock in an s-corporation.
With c-corporation, however, there are no restrictions whatsoever on who can enjoy an ownership interest in the corporation.
Classes of Stock
An s-corporation can only have one class of stock. But, a c-corporation can have multiple classes of stock conferring different rights and obligations to the shareholder.
Is a C-Corporation or S-Corporation Better for You?
For most small businesses, an s-corporation is the better option. In fact, your small business doesn't even have to be formed as an s-corporation to enjoy the tax benefits of s-corporation status––you can be formed as an LLC and then simply elect to be taxed as an s-corporation.
Nevertheless, regardless of which business entity you choose, forming a corporation can be complicated. An experienced business law attorney can not only help you select and form the business entity that is right for you, but can also educate and inform you so that you can operate your corporation with confidence.
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.