C- & S- Corporations

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Distinctions between S Corporations and C Corporations:

Your C Corporation is the default corporation under the Internal Revenue Service (IRS) rules. At the same time, your S Corporation is the kind of corporation that has elected a special tax status with the IRS. However, both structures get their names from the parts of the Internal Revenue Code, where they are taxed under. Your C Corporation is taxed under Subchapter C while S corporations are taxed under Subchapter S. Form 2553 must be accomplished and filed with the IRS to elect S Corporation status, and the applicant must meet all S Corporation guidelines.

Both C and S Corporations have the following qualities:

SEPARATE LEGAL ENTITIES

Corporations are separate legal entities that are created by state filing.

LIMITED LIABILITY PROTECTION

The shareholders are typically not personally liable for business debts and liabilities as corporations offer limited liability protection.

FILING OF CORPORATE DOCUMENTS

Formation documents must be filed with the state, and these are called either Articles of Incorporation or Certificate of Incorporation. These requirements are the same whether you decide to put up a C or S Corporation.

AS TO STRUCTURE

Both have shareholders, directors, and officers. While the shareholders are the owners of the corporation, it is the corporation that owns the business. These shareholders elect a board of directors that oversees and directs the corporation's affairs and decision-making; except, for the day-to-day operations, which are managed by the officers elected by the board.

REQUIRED FORMALITIES

The state corporation laws make no distinction between C and S Corporations when it comes to compliance responsibilities.

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Whether you choose an S or a C Corporation, the decision normally comes down to how you want the corporation to be treated for federal income tax purposes. Our dedicated team will be able to assist you in choosing the appropriate business structure for you.

S Corporations are pass-through taxation entities. They file Form 1120S – informational federal return, but no tax is paid at the corporate level. Instead, whatever profits or losses of the business are passed through to the business and reported on the respective owners' personal tax returns. Whatever amount is due is therefore paid at the individual's level.

C Corporations, on the other hand, are separate taxable entities. They file Form 1120 – corporate tax return, and they pay taxes on the corporate level. There is also a possibility of double taxation if the corporation's income has been distributed in the form of dividends, which in turn becomes taxable income. Corporate income tax will first be paid at the corporate level and thereafter on the individual level on the dividends received.

RESTRICTIONS ON OWNERSHIP

State corporation laws do not distinguish between S Corporations and C Corporations. However, there are several restrictions in place by the Internal Revenue Code as to who can be shareholders for a corporation to qualify as an S Corporation. S Corporations cannot have more than 100 shareholders who must either be United States citizens or residents; C Corporations have no ownership restrictions. C Corporations cannot own an S Corporation, and S Corporations are subject to exceptions, LLCs, many trusts, and partnerships. An S Corporation can have only one class of stock, while C Corporations can have multiple classes. While this may seem to be confusing to you, our dedicated team will be able to guide you through and assist you in determining which business structure is appropriate for your circumstances.

S CORPORATIONS

ADVANTAGES

  • SINGLE-LAYER OF TAXATION. ANY DISTRIBUTION OF INCOME TO THE SHAREHOLDERS IS ONLY TAXED AT THE INDIVIDUAL LEVEL
  • PASS-THROUGH OF LOSSES. AS THE LOSSES OF AN S CORPORATION ARE PASSED THROUGH ITS SHAREHOLDERS, IT CAN OFFSET THE TAXABLE INCOME.
  • 20% OF QUALIFIED BUSINESS INCOME DEDUCTION. ELIGIBLE S CORPORATION SHAREHOLDERS CAN HAVE UP TO 20% DEDUCTION OF NET QUALIFIED BUSINESS INCOME UNDER THE TAX CUTS AND JOBS ACT OF 2017.

DISADVANTAGES

  • LIMITED NUMBER OF SHAREHOLDERS. AN S CORPORATION CANNOT HAVE MORE THAN 100 SHAREHOLDERS WHO MUST ALL BE US CITIZENS OR RESIDENTS.
  • PREFERRED STOCK IS NOT ALLOWED. AN S CORPORATION CANNOT HAVE DIFFERENT CLASSES OF STOCKS, AND SOME INVESTORS WANT PREFERENCE TO DISTRIBUTIONS OR PRIVILEGES, SOMETHING S CORPORATIONS CANNOT PROVIDE
  • RESTRICTIONS ON TRANSFER. MOST S CORPORATIONS RESTRICT THE SALE OR TRANSFER OF SHARES TO PREVENT AN INELIGIBLE SHAREHOLDER, WHICH WILL CAUSE THE IRS TO TERMINATE ITS STATUS.

C CORPORATIONS

ADVANTAGES

  • UNLIMITED SHAREHOLDERS. THERE IS NO LIMIT AS TO THE NUMBER OF SHAREHOLDERS A C CORPORATION CAN HAVE.
  • THERE IS NO RESTRICTION ON CLASSES. A C-CORPORATION CAN ISSUE MORE THAN ONE CLASS OF STOCK, INCLUDING THOSE WITH A PREFERENCE FOR DIVIDENDS AND DISTRIBUTIONS.
  • NO OWNERSHIP RESTRICTIONS. ANYONE CAN OWN SHARES, INCLUDING NON-U.S. CITIZENS AND BUSINESS ENTITIES.
  • MORE OPTIONS FOR RAISING CAPITAL. SUBCHAPTER C OF THE TAX CODE DOES NOT IMPOSE THE SAME RESTRICTIONS ON OWNERSHIP AS SUBCHAPTER S; EQUITY FINANCING IS EASIER FOR C CORPORATIONS TO OBTAIN.
  • THE MAXIMUM TAX RATE IS LOWER. THE 2017 TAX REFORM ACT HAS LOWERED THE TAX RATE TO A FLAT 21% AND ELIMINATED THE ALTERNATIVE MINIMUM TAX.

DISADVANTAGES

  • POSSIBILITY OF DOUBLE TAXATION. C CORPORATIONS' MAIN DISADVANTAGE IS THAT IT PAYS TAX ON ITS EARNINGS, AND THE SHAREHOLDER PAYS TAX ON DIVIDENDS; HENCE, THE CORPORATION EARNINGS CAN BE TAXED TWICE IF THERE ARE DIVIDENDS.

While a C Corporation will seem to have more advantages in hindsight, that is not always the case. For a more detailed explanation as to the advantages and disadvantages of both C Corporations and S Corporations, please feel free to schedule an appointment with us. Our dedicated team will assist you and provide you the appropriate business and legal advice.

HOW WOULD YOU KNOW THAT THE PROS OF A C CORPORATION OUTWEIGH THE CONS?

There is no hard and fast rule as to when the pros of a C Corporation outweigh the cons; however, these are some situations indicative that a C Corporation is a viable option:

  • YOU WANT TO ISSUE PREFERRED STOCKS.
  • BEING TAXED UNDER SUBCHAPTER C WILL BE MORE BENEFICIAL THAN BEING TAXED UNDER SUBCHAPTER S.
  • YOU PLAN TO HAVE AN IPO OR INTEND TO SEEK INVESTORS WHO ARE PROHIBITED UNDER S CORPORATION.
  • DISTRIBUTIONS WILL NOT BE MADE TO SHAREHOLDERS.
  • YOU INTEND SHARES TO BE FREELY TRANSFERABLE.

HOW WOULD YOU KNOW THAT THE PROS OF AN S CORPORATION OUTWEIGH THE CONS?

There is no specific measure as to when an S Corporation should be chosen over a C Corporation. The decision must be based on each of the determining circumstances, but it is safe to say that the pros are to be given more weight when:

  • THE CORPORATION INTENDS TO MAKE DISTRIBUTIONS OF INCOME TO SHAREHOLDERS.
  • YOU DON'T PLAN FOR AN IPO AND ARE NOT LOOKING TO SELL SHARES TO OVER 100 SHAREHOLDERS OR ANY OTHER INVESTORS PROHIBITED UNDER SUBCHAPTER S.
  • YOUR SHAREHOLDERS' TAX LIABILITY WILL BE LOWER USING A PASS-THROUGH ENTITY THAN A SEPARATELY TAXED ENTITY.
  • YOU DON'T INTEND TO ISSUE PREFERRED STOCKS.
  • THERE IS A POSSIBILITY OF YOU INCURRING LOSSES THAT YOU WANT TO DEDUCT FROM YOUR PERSONAL INCOME TAXES TO OFFSET INCOME RESULTING FROM TAX SAVINGS.

We know that your choice in the type of entity has a massive impact on many aspects of your business, from taxes to financing your identified strategies for growth. Clearly evaluating the advantages and disadvantages of your options will aid you in coming up with an informed decision as to what is suited for your unique business needs and goals. To assist you in deciding the appropriate corporate entity type for your business, you may contact us, and one of our dedicated team will be able to assist you in making this important decision as you move forward with your business.

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