Forming a Corporation — C Corporation Versus S Corporation
This addresses the common question considered by businesspeople when forming a corporation, comparing corporations—S Corporation versus a C Corporation.
Creators of corporations almost always want to limit their liability up to the amount of the investments they make in the company, and they want to keep their taxes as low as possible. That is the spirit that moved governments to create the corporation in the first place. As we’ve indicated elsewhere on our site, in the eyes of the law, a corporation is considered a person separate and distinct from its owner(s), created by the actions of its creators. Because of this, any liability of the corporation is generally limited to the money or other assets that the corporation has and not to those of its owners—because the corporation is liable for its actions as if it were a person separate and distinct from its owners. In other words, forming a corporation creates an entity that is separate from its owners and can be liable for its actions without necessarily making the owners liable too. Thus, simply stated, the corporation can in most cases shield its owners from the actions taken by the corporation.
The corporate concept is tied to the word itself, “corpus” which is Latin for body. By making a corporation, you are creating a person, other than you, in the eyes of the law. The main reasons for making a separate entity, though, do not require a review of history, a law degree, or any desire to know ancient languages. The reasons are timeless, and no doubt at the top of your mind as you read this article: limited liability and taxes. A corporation is a separate entity a person creates to limit their liability to the amount of money that they invested in it, and its shape and form are influenced, if not dictated, by tax law. Forming a corporation requires important preliminary decisions—and few are more important than the suitability of an C Corporation versus an S Corporation.
Forming a C Corporations—What is it?
Historically, there was only one type of corporation. Those today are known as C Corporations. As mentioned, the corporation was intended to limit the owner’s liability—that is, the owners would generally not be individually liable for the acts of the corporation beyond the amount they invested. The downside, however, was that as a legally separate person, the corporation’s income and gains were taxable like anyone else’s. So, under a C Corporation the income to the corporation is taxed, and then any dividends or profits distributed to owners are generally taxed producing, in effect, double taxation (which is great for the taxman but not so great for you).
Because C Corporations are the basic form of corporation, they have less restrictions on the number of owners, type of owners (that is non-residents and even other corporations can be owners), classes of stock that can be issued, and actions of the corporation.
Forming an S Corporation—What is it?
Types of businesses, like anything else, evolve over time. While a corporation was a great idea in its day—and still is for many business models—over the years different types of business models arose that limited the owner’s liability while also better addressing the taxation issues for the owners by avoiding the double taxation still seen for C Corporations. Corporate law developed and state laws created entities that limited the liability of owners in various ways, as with a Partnership, while allowing the income to flow right through to the individual (often called “flow through” or “pass through” taxation”) and taxed at the personal level only without also being taxed as income to the business itself (to avoid double-taxation). People looking at forming a corporation were looking for that same kind of protection—and the Internal Revenue Service (“IRS”) finally followed the states’ lead and settled on a practical compromise.
While your corporation may look the same to the rest of the world regardless of whether it is a C Corporation or an S Corporation, federal law allows you to register the entity as an S Corporation when it is made. Selecting for treatment as an S Corporation entitles the entity’s profits to flow through to its owners and be taxed at the individual level (avoiding double taxation for the taxman), but to do so the person who incorporates the business must be willing to take on certain limits. To be an S corporation the incorporators must comply with the IRS code in all its detail—and failing to do so tosses the corporation back into being a C Corporation or result in penalties.
The first requirement is to declare (to the IRS basically), early in the incorporation process, that you want the corporation to be treated as an S Corporation. There are time limits in the law, and without attention to them, you may find that your corporation will be taxed as well. With the required declaration, the IRS will allow income distributed from the corporation to flow through to the individual owners on a separate form on their income taxes. At the time of creation, other requirements must be looked into. Typically an S Corporation is limited to 75 owners, only one class of stock, and limits ownership by non-residents, corporations and trusts.
Conclusion – C Corporation versus S Corporation
The fundamental way to see the difference between C Corporations and S Corporations is to look at a C Corporation as a conventional corporation, while seeing an S Corporation as a creature of tax law, only available when you select that your corporation be so treated at its formation in accordance with IRS requirements. For these reasons, one looking to form a C Corporation or S Corporation must consider from the start how they wish for it to be taxed, and whether they are willing to comply with the many requirements in order to be granted the flow through treatment of the S Corporation. It’s best to seek the advice of qualified accounting and legal counsel when determining which entity to choose and qualified specialists when forming the entity.
Once you have decided after weighing the benefits of C Corporations versus S Corporations, Elite Incorporation is ready to form your company and further your vision.