Every business has a structure that determines its operation and how the government will recognize it as a legal entity. Different business structures offer different benefits and restrictions, so it’s essential to understand what’s at stake in how you organize your business.
One common and important structure is the corporation. Corporations are legally independent business entities owned by their shareholders. Unlike sole proprietorships, a corporation exists apart from its owners, and the owners often have little or no role in everyday business functions.
If you’re planning on forming a corporation, you should also be aware of the different types of corporations. Depending on what paperwork you file with state and federal authorities, you can form either an s-corp or a c-corp.
What Is an S-Corp?
An s-corp is a business entity that qualifies as a pass-through entity for tax purposes. Small corporations that meet particular IRS standards can file to be recognized as an s-corporation, which will simplify their tax obligations and allow owners to file business income directly on their personal tax returns.
To form an s-corp, an already existing corporation must submit IRS form 2553, election by a small business corporation, and prove that they meet the requirements of the status.
What Is a C-Corp?
A c-corp, meanwhile, is the regular business structure for most corporations. Forming a c-corporation gives you a flexible business structure with a lot of liability protection. This is the default type of structure for a new corporation.
C-Corp and S-Corp Differences
S-corp status aims to support small business corporations, primarily with federal tax obligations. Not all states recognize it as a separate status from c-corp, however. Here are some of the fundamental ways the two structures differ:
A c-corp is effectively taxed twice, once at the corporate level according to the corporate tax rate, and then again as the business income passes to individual owners and employees.
S-corporations allow pass-through taxation to avoid having your business taxed at the corporate level. Owners instead claim all of a company’s income on their personal tax returns.
Forming any small business that creates separate legal entities will require filing official paperwork with your local secretary of state. However, an s-corp is a small corporation with special federal tax status, so you will have to file the articles of incorporation for a c-corp before you can then apply specifically for s-corp status.
Follow these basic steps for forming a corporation:
- Choose a name
- Create your business plan
- Appoint a registered agent
- Select your initial board of directors
- File articles of incorporation and pay filing fees
These steps will be the same for s-corporations and c-corporations. S-corporations, however, must be domestic U.S. corporations. Some entities like insurance companies or certain financial institutions are not eligible for s-corp status either.
Ownership works similarly for both c-corps and s-corps. The corporation owners are not necessarily those responsible for any regular business operations but those that own stocks in the company. The corporation reduces private liability for any debts or losses this way.
Stockholders will have a say in how a corporation is run, but they are not directly responsible for most decisions. They invest money in the company and then receive a share of the profits as a reward.
An s-corporation is a pass-through entity, while a c-corporation is not. This means that business income passes through the s-corp to go directly to its owners. This works the same way for a limited liability company. All corporate income is divided among shareholders and claimed only once on the owners’ personal income taxes.
Larger c-corporations must pay taxes at the corporate level according to the corp tax rate before that income continues to shareholders.
Any owner or employee of a corporation will have to pay taxes on any income they receive through the corporation, whether it’s an s-corp or a c-corp. For the s-corp, all of the company’s revenue and expenses must be accounted for in its owners’ personal tax returns. Profit can be distributed however the company has agreed to distribute it, but it must all be accounted for.
For the c-corp, however, there are more options for how to handle profit distribution. Corporation leadership can decide to retain profits or use it however they like. The most common avenue for distributing profit to owners is through dividends.
Owners also involved in working for the corporation must also receive some kind of reasonable wage or salary.
To qualify for s-corp status, a corporation can have no more than 100 shareholders. However, it is simple to change status as your company grows. Once your number of shareholders goes beyond 100, you can revert to a c-corporation.
Each of an S corporation’s shareholders must also meet certain requirements. Shareholders must have legal residency or citizenship in the United States, and they cannot be partnerships or corporations themselves. Each shareholder must be an individual or specific kinds of trusts and estates that also qualify.
Issuing stock is one of the core defining practices of a corporation. You raise funds by publicly trading ownership of your company. C-corporations have many choices for how and when to issue stock, but S-corporations are only allowed to have one class of stock.
Get Help to Build Your Business
If you’re uncertain about any of these important business decisions or want help with planning and paperwork, consider working with an accountant. Accountants can help small businesses succeed and get ahead of the competition. If this is your first time, work with an expert at 1800-Accountant who can help you through the process.
There are many benefits to running your corporation as an s-corporation if you meet the requirements, but it can take a lot of time and effort to ensure your business is fully compliant with all the laws governing your tax status. Working with a professional at any point in the process can help you reduce your workload and increase your efficiency for the sake of your business and its future.