A Tale of Two Business Structures / Comparing C corporations with S corporations

If you are organizing a new business structure, you may prefer to set up a small company as a traditional C corporation or an S corporation. Alternatively, you might switch from one to the other for an existing business. Before you make your final decision, be aware that there are certain similarities, as well as differences, between the two popular business forms. The following is a brief overview of the two formats.

The Similarities

*Each structure offers certain liability protection, so individuals with ownership interests generally will not be held personally liable for business debts and liabilities. This is often called the “corporate shield” or “corporate veil.”

*Both corporations are separate legal entities governed by state law. For example, documents establishing a C corporation or S corporation—often called “articles of incorporation”—must be filed with the state. These documents are essentially the same for C and S corporations.

*C corporations and S corporations have shareholders, directors and officers. Shareholders elect a board of directors that has oversight of the business. The board chooses the officers to manage the day-to-day affairs of the business.

*Comparable corporate formalities must be observed such as adopting bylaws, issuing stock, holding shareholder and director meetings, and filing annual reports.

*With either type of corporation, personal income tax is due on any compensation or dividends received by the owners or shareholders.

The Differences

*Generally, the C corporation format is standard, while a special election for S corporations must be filed with the IRS. The S corporation election must be made by the 15th day of the third month of the year to be valid for that year (e.g., March 15, 2017, for the 2017 calendar year).

*Other special requirements apply to S corporations. For instance, the number of shareholders cannot exceed 100, and the shareholders must be U.S. citizens or residents. These restrictions do not apply to C corporations.

*The main difference is taxation. With a C corporation, income is taxed first to the entity and then on amounts paid to owners as compensation, and dividends are personally taxable, thus resulting in “double taxation.” Conversely, with an S corporation, there is no tax on the entity level. Profits and losses are passed through to shareholders and reflected on their personal income tax returns. For many entrepreneurs, this becomes a prime consideration.

A long trend toward switching from the C corporation format to S corporation status has somewhat abated because the highest individual tax rate of 39.6% currently exceeds the top corporate tax rate of 35% (38% on certain income). Nevertheless, this remains a viable option for some business owners. The decision about a business structure should take all the relevant factors into account.

Reminder: Another option, the limited liability company (LLC), is available to business owners and has been gaining in popularity in recent years. When considering all your options, seek guidance from your tax and professional advisers.