New businesses looking to achieve the benefits of incorporation, such as limited liability protection and improved credibility, are often faced with a difficult decision. Should they incorporate as a C corporation or an S corporation?
There are three key differences between C-corps and S-corps—outlined below—that every entrepreneur should understand before making their decision. Please keep in mind that this blog is not intended as legal advice for your specific situation. Every company is unique, and the choice whether to incorporate as a C-corp, S-corp, or some other entity will be entirely dependant on your unique circumstances and goals. Always consult with a skilled business attorney like those at Integrated General Counsel before moving forward with incorporation.
Formation
The formation of a C corporation and an S corporation are in fact exactly the same in most cases—with S-corps following most of the same corporate formalities as C-corps—with the exception of one major variation. The key difference in formation is that an S-corp is formed when the incorporating business elects for a special tax status with the IRS by filing Form 2553. S-corps get their name because the tax status is defined by Subchapter S of the Internal Revenue Code. So, an S corporation is actually just a tax designation for an underlying C corporation. Keep in mind that it is also possible to elect for S-corp status as an LLC, in which case the formation would follow the procedures required to form an LLC while also filing Form 2553. In order to be granted “S” status for taxes—whether as an underlying corporation or LLC—you must file with the IRS within 2 months and 15 days of filing your articles of incorporation or articles of organization.
Taxation
Taxation is by far the biggest difference between C-corps and S-corps. It is also generally the entire reason someone would choose to file as an S corporation rather than a C corporation. C-corps are considered separately taxable entities and they are taxed at the corporate level. What this means is, the business entity will be taxed on its revenue, while the individual owners will also be taxed for that same revenue if they receive a salary or dividends. This means that the same revenue is actually being taxed twice, which is known as double taxation. S-corps, on the other hand, are taxed similarly to an LLC with “pass-through” taxation. All corporate profits and losses pass through to the individual income taxes of the owners. Thus, these profits are only taxed at the federal level once. Keep in mind, however, that the State of California does tax the corporate profits of S-corps before they are distributed to shareholders. They are taxed at a rate of 1.5% as opposed to 8.84% for C-corps.
Ownership
The final key difference between C-corps and S-corps is requirements regarding ownership. While C-corps have no real restrictions on ownership, S-corp ownership regulations are relatively strict. S-corps cannot have more than 100 shareholders, all of whom must be US citizens or residents, and they can only distribute one class of stock. They also cannot be owned by a corporate entity, like another C-corp.
If you are forming a business in the State of California, and you are deciding whether to incorporate as a C corporation or an S corporation, please contact Integrated General Counsel today and let us advise you on your best course of action based on your business goals, as well as help guide you throughout the process to ensure you are compliant with all laws and regulations.
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