S Corporation vs. C Corporation
Forming a business entity can be complex, especially for those who aren't sure about the distinctions between classes. Although they're similar in many ways, S corporations and C corporations have a few critical differences that affect both their modes of operation and the way they're taxed.
Understanding Corporations in General
In C corporations, any monies or assets that are earned or lost by the company are the responsibility of the firm and its shareholders. This is unlike an S corp or an LLC in which the firm's owners hold profits and handle losses directly.
A corporation also requires a board of directors to function. This body is ultimately responsible for the allocation of assets and fiscal resources, and most are tasked with routine operation and management as well.
How Do Taxes Work for C and S Entities?
In terms of its pass-through status, an S corp is somewhat similar to an LLC; a C corp that files an IRS Form 2553 to become an S corporation gains the right to have its profits and losses reflected onto shareholders. In either type of setup, shareholders pay taxes on dividends they earn. The main difference is that with C corporations, the entity will also pay corporate taxes. These taxes may fluctuate based on state and federal regulations, but some business owners prefer it that way; C corporations that hold significant quantities of money or assets can potentially reduce the amount of shareholder obligation and minimize the phantom income phenomenon.
Which entity is better? Both have their tax advantages, especially when future expansion is a consideration. Founders who want to retain more control may decide to maintain C corporations, but the fact that C corporations can become S corporations also grants them increased flexibility. It's worth noting, however, that entities that migrate from C to S status may end up owing taxes on profits that originated during their time as C corps.
Stocks and Capital
The pass-through tax benefits afforded to S corporations are somewhat offset by the fact that these corporations are only permitted up to 100 shareholders and a single type of stock. C corporations may offer both common and preferred stocks, and there are no rules about how many shareholders they have; this facilitates IPOs and other capital aggregation actions.
Startup firms whose founders want to keep things small often find that S corporations are entirely adequate. On the other hand, venture capitalists and angel investors sometimes favor C corporations due to their heightened legal indemnity. It's usually wise to seek advice about your specific goals prior to making a final decision.
Forming a Corporation
The formation processes for new S and C corporations are very similar. Founders need to submit the correct paperwork, but they also have to provide evidence of shareholder agreements, organizational board resolutions, articles of incorporation and stock information. As with any business formation, it's essential to follow the correct procedure.