Corporations offer limited liability protection, so shareholders (owners) are typically not personally responsible for business debts and liabilities. This is true whether it is taxed as a C corporation or an S corporation. Deciding between an S or a C corporation is not always a simple matter. The San Luis Obispo corporate law attorneys from Toews Law Group, Inc. believe that understanding the similarities and differences between the two is important to helping you choose.
The S and the C corporation get their names from the relevant parts of the Internal Revenue Code:
- The C corporation is the default corporation, meaning that if you don’t file an S corporation election, the corporation is automatically classified as a C corporation. Subchapter C of the IRS code defines how C corporations are taxed.
- S Corporations are taxed under Subchapter S of the IRS code. Forms 2553 must be filed with the IRS to receive the S corporation designation.
Both S and C corporations are separate legal entities created by filing the appropriate documents with the state in which they are doing business. For California, this is the Office of the Secretary of State. As separate entities, corporations provide limited liability protection, shielding shareholders from certain liabilities incurred by the corporation.
Formation documents that are filed with the state include Articles of Corporation, Certificate of Incorporation, and other information such as number of stock shares, names of the Board of Directors, and the business address.
Both S and C corporations have shareholders, directors and officers. Shareholders are the owners of the corporation but the corporation owns the actual business. Shareholders elect the board of directors, which is responsible for overseeing and direction corporate affairs and decisions. The officers, such as Chief Executive Officer and Treasurer, are responsible for managing the day-to-day business of the corporation.
The board oversees and directs corporation affairs and decision-making but is not responsible for day-to-day operations. The board elects the officers to manage daily business affairs.
The S and C designations for a corporation are federal designations. State corporation laws don’t distinguish between an S or a C corporation for compliance with state incorporation laws. All corporations are required to follow certain formalities and obligations such as adopting bylaws, filing annual reports, holding shareholder and director meetings and paying annual state fees and taxes.
San Luis Obispo corporate law attorneys at Toews Law Group, Inc can answer your questions and explain the overall benefits of incorporating either as an S or C corporation.
The main differences between S and C corporations concern taxes, and ownership/shareholders.
- S corporations are pass-through taxation entities, meaning that the corporation files Form 1120S, and information federal return and the profits and losses, including tax liability are passed through to the business and reported on the owners’ personal tax returns. This can provide financial benefits to the owners’, because writing off losses against personal income reduces the personal tax liability.
- C corporations are separately taxable entities, file a corporate tax return (Form 1120) and pay taxes at the corporate level. If the corporation distributes dividends as income to the business owners, those dividends are taxed at the corporate level and again at the individual level.
Personal income tax is due for salaries drawn from both S and C corporations.
Who owns the corporation?
Ownership is an important issue, especially where control and management of the corporation is concerned. Generally speaking, the shareholders own the corporation and there are restrictions to share ownership. The differences come from the number of shareholders allowed and the structure of the entity.
- S corporations are restricted to no more than 100 shareholders, who must be U.S. citizens or residents. C corporations have no restrictions on the number of shareholders.
- Shareholders for an S corporation must be individuals. Another S or C corporation, nor an LLC, cannot “own” an S corporation. There are also some restrictions on trusts owning S corporations.
- S corporations can only have one class of stock, while C corporations can have many classes.
There is no single answer to when a small business owner should choose an S or a C corporation. Many factors come into play such as whether you are operating the business yourself or with partners (shareholders), your overall business goals, and taxation considerations.
The wisest step before deciding is to take your business plan to the San Luis Obispo corporate law attorneys at Toews Law Group, Inc. for a review and solid legal advice. Corporate law includes everything from how your business is established, to employee matters, regulatory matters, insurance and reducing liability, to litigation. Starting off with sound legal advice gives your business the solid foundation needed to become successful.
Call today for your appointment.