Distinctions Between C Corporations and S Corporations

If you are considering forming a business, you will have several important legal considerations ahead of you. One of the most important choices you will need to make is what type of business entity you wish to create. If you have decided on a corporation, you will still need to determine the type of corporation best fits your needs. Generally, this is a question of forming either a C corporation or an S corporation. There are some important distinctions between these two types of corporations that can have a significant impact on your business.

C Corporations

C Corporations are traditional corporations. A C corporation is labeled as such because it is taxed under the Internal Revenue Code’s subchapter C. C corporations provide some additional protection for shareholders when it comes to business-related debts in that they are typically not personally liable for them. C corporations can also have an unlimited number of shareholders, which allows the corporation to release stock and raise capital for business-related purposes. The majority owners of C corporations can also issue different classes of stock for different purposes, which can help attract investors.

C corporations can be structured in a way that allows them to split profits between the shareholders and the corporation itself, which can result in tax savings because the corporate tax rate is typically lower than individual tax rates. C corporations can also write off the entire cost of certain business expenses, like health plans. With a C corporation, these benefits remain tax-free even for shareholders receiving them, whereas there are stricter limitations on this benefit for S corporations.

S Corporations

An S corporation is an entity formed through an IRS tax election. The main difference between an S corporation and a traditional corporation is that an S corporation is not taxed. In other words, any profits or losses within an S corporation will pass through to the shareholders of that corporation. In turn, shareholders are liable for taxes related to those profits and losses. Keep in mind that this type of tax structure universally applies only to federal taxes. Individual states may differ in their approach to taxing S corporations, and some may not even recognize the distinction.

An important benefit related to S corporations is that they retain the ability to have their own “life” independent of shareholders. In other words, if a shareholder leaves the corporation or were to sell off their shares, the business would typically be able to continue in relatively the same fashion as before with little to no disruption caused by the change in shareholders.

Certain expenses incurred by shareholders/employees may also be eligible to be written off as business expenses. Another important advantage for S corporations is that they can provide for significant tax savings. For some types of business entities other than S corporations, employment taxes are levied based on the net profits of the business. However, with an S corporation only wages of a shareholder within the S corporation are subject to the employment tax.

You should be aware that the IRS imposes shareholder compensation requirements. Running afoul of this requirement by falling into the trap of providing low salaries with high distributions for shareholders will cause the IRS to take notice and risk the implementation of a higher employment tax. There are also strict guidelines about operational procedures, such as the need for regularly scheduled director and shareholder meetings and the preservation of minutes from such meetings.

Florida Business Formation

Owners of either type of corporation are typically shielded from personal liability. They also enjoy a lower risk of being audited by the Internal Revenue Service based on their more transparent tax structures when compared to other types of business entities. If you are considering forming a business, especially a corporation, it is important to understand the complex legal process that is involved. Contact the business-focused legal team at Jurado & Farshchian at 305-921-0440 or email us at [email protected] to schedule a consultation. We can help you decide which business structure best addresses your needs.

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