By: Steve Masur
When forming a corporation, an important decision to consider is whether to form as a default C-Corporation (“C-Corp”) or elect for the corporation to be an S-Corporation (“S-Corp”). This distinction can carry major implications for the corporation, such as the way the it will be taxed or the rights of its shareholders. It is crucial to understand the differences as well as the similarities between the two corporate structures and which one is more beneficial for your corporation’s needs.
A C-Corp is the traditional, default structure of a corporation. It is created when the incorporator files the formation documents with the governing state. In a C-Corp, the shareholders own the corporation, but the shareholder-elected board of directors carries out the management and day-to-day operations and responsibilities of the corporation. The C-Corp shareholders have limited liability protection, meaning that shareholders are typically not liable for the debts or liability of the corporation.
The S-Corp derives its name from Subchapter S of the Internal Revenue Code, which provides corporations to elect its tax status. To form an S-Corp, the corporation elects a special tax status with the IRS by filing Form 2553. Similar to a C-Corp, shareholders of an S-Corp also have limited liability protection and the board of directors are responsible for all managerial decisions on behalf of the corporation.
Taxation is one of the biggest differences between an S-Corp and a C-Corp. C-Corps are subject to double taxation. The C-Corp is first taxed at the corporate level when the corporation files its corporate income tax return using Form 1120. Its shareholders can then be taxed again on their personal income tax returns if the corporate income is distributed to the shareholders.
S-Corps may take advantage of pass-through taxation, meaning that the corporation’s profits are directly passed to the shareholders. The corporation’s income and losses of the business are divided among the shareholders. The shareholders report their share of the business’s income and losses on their personal tax return and thus, are only taxed at the personal income tax level and not subject to the corporate tax.
Size and Type of Ownership
C-Corps are typically more beneficial for larger corporations, especially those with international aspirations. In a C-Corp, there is no limit to how many shareholders the corporation may have or where the shareholders must live. By contrast, S-Corps can have no more than 100 shareholders, all of whom must be residents or citizens of the United States. Additionally, C-Corps can be owned by other business entities, such as LLCs, trusts, or other corporations, whereas S-Corps can only be owned by individuals.
Both S-Corps and C-Corps can issue stock to its shareholders, however, C-Corps have more flexibility in issuing stock. C-Corps can issue different classes of stock, which divide up the shareholders’ voting rights. Early investors in C-Corps typically have more voting rights with their shares, affording them more voting power over other shareholders. This means that some shareholders’ votes, depending on their class of stock, are weighted more than other shareholders’ votes. S-Corps, however, may only issue one class of stock, meaning that all shareholders have the same voting power.
While S-Corps and C-Corps are similar in many ways, their differences can have a major impact on the way the corporation operates. C-Corps are generally more beneficial for larger companies due to the lack of restraints on the number of shareholders allowed in a C-Corp. While shareholders in a C-Corp have more flexibility with voting rights and ownership, this advantage comes at a price; C-Corp shareholders face double taxation, unlike S-Corps that utilize pass-through taxation.
Structuring your corporation as a C-Corp or S-Corp is a big decision with big potential implications for the future of your corporation. MG+ can help you choose the best corporate structure for your corporation based on your corporation’s needs and future aspirations. Contact us at firstname.lastname@example.org or (212) 209-5450.