What is a corporation?
A corporation is a type of business entity formed by filing articles of incorporation with your state. The owners of a corporation are called shareholders, and corporations also have officers and directors who run the business. Corporations are considered separate legal entities from their shareholders, and shareholders are not personally liable for the corporation's debts (shareholders' liability is limited to the amount they invested in the business). Corporations are subject to several legal requirements and “corporate formalities” that do not apply to other types of businesses.
The terms “C corporation” and “S corporation” refer to tax classifications that apply to both corporations and limited liability companies (LLCs). Corporations are taxed as C corporations by default, but some can elect to be taxed as S corporations instead. LLCs are typically taxed as sole proprietorships or partnerships, but can also elect to be taxed as a C corporation or S corporation.
C-Corps Basics
A C corporation is the most common corporate tax status. Like an S corporation, it gets its name from the subchapter of the Internal Revenue Code under which it is taxed. Tax requirements are the main attribute that makes a C corporation a C corporation and an S corporation an S corporation.
A C corporation must first file an IRS-mandated federal return (Form 1120) and pay corporate income tax. Then shareholders must pay personal income tax at the individual level on any dividends or gains from the sale of stock. This arrangement is called “double taxation” because dividends are taxed at both the corporate and personal levels. C corporation shareholders cannot offset corporate losses against other income on their personal income statements.
C corporations are preferable because there are no restrictions on who can own shares. Other corporations and organizations, both in the U.S. and abroad, can have ownership interests in a C corporation. There is also no limit to the total number of shareholders. Shareholders in a C corporation have the full liability protection of any other corporation.
S-Corps Basics
The most distinct feature of an S corporation is its so-called “pass-through” taxation. S corporations are exempt from federal corporate taxes; instead, dividend income is taxed only at the individual level. This also means that shareholders can offset corporate losses against income from other sources if they meet certain criteria. As a separate entity, an S corporation enjoys all of the same protections from liability provided by corporate status.
There are many strict rules for operating as an S corporation that may disqualify or discourage companies that would otherwise seek S corporation status. S corporations cannot have more than 100 shareholders, effectively excluding corporations that want to go public. Ownership is primarily limited to individuals, who must be U.S. citizens or permanent residents. It is also limited to certain domestic trusts, estates, and tax-exempt organizations.