S Corporation vs. C Corporation

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Which corporate structure is right for your business?

If you're starting a business, you'll want to compare S Corporation vs. C Corporation to understand the number of important differences between these two forms of incorporation before deciding which is the best option for your venture.

Understanding Incorporation

When starting a business, consider the benefits of organization as a corporation rather than as a partnership or sole proprietorship. The law views corporations as legal entities, which means that this form of business provides owners with protection from many types of legal liabilities.

When you operate a business that is not incorporated, whether you function alone as a sole proprietor or you are in a partnership with one or more other people, you have personal liability for all of the company's actions, liabilities, and financial obligations. When you're a shareholder in a corporation, your potential exposure to liability is limited.

Different Types of Corporations

There are two different types of corporations. Once you've decided that a corporate structure is the best form for your business, you'll need to really look at S Corporation vs. C Corporation facts.

Setting Up a C Corporation

The most common corporate structure is the C Corporation. When considering whether or not this is the right corporate structure for your new business, it's important to understand how taxes are handled for C Corporations. C Corporations are responsible for paying corporate income taxes on all profits. The shareholders must also pay personal income tax on any money they receive from the company, whether in the form of regular paychecks, bonuses, or dividends. This results in double taxation, since earnings are taxed at the corporate level, and then again after being passed on to shareholders.

Setting Up an S Corporation

If you choose to incorporate as an S Corporation, you'll enjoy the liability benefits of incorporation, and your earnings won't be subject to the double taxation that characterizes C Corporations. S Corporations deal with profits and taxes in the same manner as partnerships. The primary benefit of incorporating as an S Corporation has to do with how taxation is handled.

S Corporations are pass through entities. These types of corporations are not subject to most types of corporate income taxes. Instead, profits pass through to the shareholders and are taxed only as personal income. At tax time, each shareholder receives a K-1 form reporting his or her share of the S corporations profits or losses, and appropriate taxes are assessed on the owners' personal income tax returns.

When comparing tax issues for S Corporation vs. C Corporation, it's easy to wonder why any business owner would opt for the C structure rather than the S option. However, it's important to realize that there are limitations regarding which types of businesses can opt for this organizational structure.

S Corporation vs. C Corporation Facts

  • Number of Shareholders: S Corporations cannot have more than 100 shareholders. While this limitation isn't likely to exclude small businesses, this form of incorporation won't work for most major corporations, particularly those that are publicly traded. C Corporations can have an unlimited number of shareholders.
  • Stock Classes: S Corporations can issue only one class of stock, while C Corporations can have several different classes of stock.
  • Taxation: S Corporations are pass through entities. They typically do not pay corporate taxes; instead profits are passed through to the shareholders who pay personal taxes on their share of earnings. C Corporations are responsible for paying corporate taxes on profits, and shareholders must also pay personal income tax on all monies received from the entity.
  • Treatment of Corporate Losses: With an S Corporation, shareholders can take a tax deduction for corporate losses, since the losses are passed through to the shareholders in the same manner as profits are passed through. With a C Corporation, corporate losses are not tax deductible to shareholders.

Choosing the Best Structure

If your intent is to take your corporation public or you intend to issue more than one class of stock, going with a C Corporation structure is in your best interest. If you plan to keep your operation small and limit the number of shareholders and classes of stock, going with an S Corporation structure may be best for you. Only you can decide which corporate structure is best for your business, and it's certainly a good idea to consult with an attorney or certified public accountant before making this important decision.

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S Corporation vs. C Corporation