Should My Business Be a Corporation?

August 19, 2011

When starting a business or changing the formation of your business structure, one of the most common options small business owners evaluate is whether to form an S corporation or a C corporation. These are the two most common ways to incorporate, and the choice will depend on your current and future business goals.

C Corporation

Almost all large corporations with more than 100 shareholders and virtually all publicly traded companies are C corporations.   Companies considering going public, seeking venture capital, or taking on equity investors are also usually C corporations.   A C corporation may offer the greatest flexibility, but it also carries a heavier tax responsibility through a process known as “double taxation.”   Advantages of a C corp include the ability to have any number of shareholders, allowing shareholders to be individuals (both US citizens and non-US citizens) or even other corporate entities themselves; and the ability for C corporations to issue more than one class of stock.  Corporations have an advantage when it comes to raising capital for their business – the ability to raise funds through the sale of stock.

Double taxation is, perhaps, the biggest drawback to a C corporation.  In a C corporation, income is taxed once at the corporate level; then, after that same money makes its way to owners (shareholders) as dividends, it is taxed again at the personal level. (In comparison to an S corporation tax structure, where the corporation itself is not taxed at all; profits are taxed only on the individuals’ tax returns).

S Corporation

An S corporation is really a special type of corporation created through an IRS tax election.  An S corporation may offer a lower tax burden than the C corporation, but the trade-off comes in the form of a more rigid corporate structure.   What clearly differentiates the S Corp from a traditional corporation (C Corp) is the ability to have profits and losses pass through to the shareholder’s personal tax return, this is known as a being a “pass-through entity.”  In the S corporation tax structure gains and losses are reported only on the owning individuals’ tax returns, and much less money is lost in the form of federal taxes.

While S corporations enjoy tax benefits, there are other restrictions and limitations that typically make S corporations a good option for smaller corporations.  Restrictions include, a maximum of 100 shareholders, all of whom must be US citizens or resident aliens, and the corporation is limited to issuing only one class of stock.  As a separate structure, S corps are also required to hold scheduled director and shareholder meetings and publish meeting minutes, updates to by-laws, stock transfers and records maintenance.

The US Small Business Administration provides a wealth of business start-up, accounting, and management information through its website.  It is always important for owners of small businesses to closely follow tax developments on the federal and state levels with the potential to affect the tax treatment of their particular business entity, including LLCs and corporations.  You should always consult your tax professional with questions about tax advantages of a corporation, and to stay current with tax law changes affecting your business.

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