Introduction

There are generally two different types of corporations to choose from when deciding on the specific corporate structure that is right for your business. These two types of corporations are the S Corporation and the C Corporation. The main reason why a business owner needs to choose between these two statuses is for reasons of taxation. Each classification has its own unique advantages and disadvantages. Likewise, depending on the business type that you choose, you will have different taxation responsibilities. In the next paragraphs you will be able to read more about just what an S Corporation and a C Corporation are as well as advantages and disadvantages to both. You will then have the opportunity to compare these two business types and decide for yourself if one better suited for you corporation's goals.

C Corporation

A C Corporation pays taxes under what is called a Subchapter C tax code. A C Corporation offers liability protection that is appealing to most big businesses and some small businesses. Large companies typically qualify only under the C Corporation because of their size and the public nature of their business. In other words, a good majority of companies who are classified as C Corporations are classified as such by default, in that other classification options are simply impractical.

A C Corporation also goes by the name of "A profit corporation." In A C Corporation, income taxes are paid by both the corporation and shareholders. If the C Corporation incurred any losses, those losses remain the property of the C Corporation and made the responsibility of the shareholder. Even in the case of bankruptcy, the owners of the C Corporation are not liable for any debts of the business.

Most large corporations, having more than seventy-five shareholders prefer "C" corporation filing because these companies expect to distribute dividends and any accumulation of capital gains to shareholders. The existence of such shareholders means that for taxation purposes the C Corporation is at a disadvantage because income taxes are paid twice or there is a factor of double taxation. A C Corporation is taxed as one entity and the individuals comprising it are taxed as a separate entity. The corporation must pay federal taxes on all profits, and shareholders pay taxes on their dividends.

A main employee advantage for those working for a C Corporation is that they may be offered a Flexible Benefit/Spending plan or Cafeteria Plan which, according to Code Section 125, "entitles employees, and their families to receive a variety of health benefits, offered by the corporation, and certain amount of payroll deductions are taken on a before-tax basis, which pays part of the expense or employer-sponsored salary reduction programs."

S Corporation

Like the C Corporation, the S Corporation is named after the Internal Revenue Code section that allows it. An S Corporation is a corporation which has elected for its profits to be taxed in the manner of an unincorporated entity, meaning there is no double taxation. Like C Corporations, not all corporations can opt to become an S Corporation. Those applying for the status of S corporation are typically small businesses, such as retail, consultants, partnerships, sales driven organizations, family businesses or companies maintaining depreciating assets. Due in part to the factor of depreciating assets, an S Corporation's passive income does not exceed 25 percent of the total income, such as annuities, dividends, royalties or other sources.

Subchapter S is ideal for smaller companies. These companies do not typically need to worry about shareholders as their number of shareholders is typically significantly less than the number of shareholders that a C Corporation has. An S Corporation typically has less than 75 shareholders, all of whom agree to incorporate the business under an "S" corporation. The S Corporation has the significant advantage of avoiding double taxation. Another advantage of the S Corporation is that it does not pay federal taxes. Business profits pass through to individual stockholders, who then must report them on their individual tax returns. This is done when the corporation sends once a year to shareholders a K-1 Internal Revenue Tax Form. The form reports the distribution of any income to shareholders, and any loss passed onto the shareholder, from the corporation. It is then the shareholder's responsibility to include this distribution of income information in the filing of their own personal taxes. Likewise, if there are losses, the shareholders can use those losses as a deduction on their individual tax returns.

Advantages of a C Corporation compared to an S Corporation

If you are basing your classification decision solely on tax benefits, than choosing an S Corporation may seem like the obvious answer. After all, who wants to have to pay taxes twice? However there is more to making this decision than basing it on the existence of double taxation alone. Smart big business owners know that double taxation issues can actually be neutralized through re-investing corporate earnings. If a corporation earns and reinvests modest amounts of profit in the business, the tax rates may be lower. Overall, tax rates applicable to many individuals in a C Corporation are lower than the rates that would apply to an S corporation even when the employees or owners of the two different corporations are at the same income level.

Also, there are tax-free fringe benefits for shareholder-employees belonging to a C Corporation. In this situation fringe benefits include such things as pension plan contributions and health care availability. The corporation can make pension fund contributions or buy health insurance for employees without having those benefits taxed. These pension fund and health insurance expenditures are actually tax deductions for the corporation.

A C Corporation is not confined by the rules of issuing shares the same way that an S Corporation is limited. C Corporations can have a great deal more shareholders than an S Corporation and the shares that are issued can be of varying classes. Furthermore, shareholders are not required to be U.S. Citizens or permanent residents as is the requirement to own stock under an S Corporation. When this source of equity capital is not restricted, the C Corporation has greater opportunities for more rapid growth. C Corporations are also easier to manage estate planning under.

Advantages of an S Corporation compared to a C Corporation

One of the first things that those forming an S Corporation find most appealing is that those with S Corporation status are not required to pay both corporate and individual income taxes. However it is only fair to note that because the shareholders are not subject to double taxation, they may end up paying a higher personal income tax rate. When total taxes are considered over the course of the year, both on the corporate and on the individual level, those belonging to an S Corporation almost always end up paying fewer income taxes.

Employment tax rules are also favorable under an S Corporation versus a C Corporation. In Corporations such as the S Corporation where shareholder-employees are in smaller numbers, it is possible for all of the corporation's profits to be extracted in the form of a salary that is paid. This means that the corporation can pay out its profits in the form of wage increases or bonuses at the end of the year, making the taxable amount for income zero. When income is zero there is no need to pay income taxes. Employee-shareholder wages are subject to employee taxes but payments taken out of profit and distributed to shareholders are not subject to employment taxes.

Similarities between the two corporation types

Generally, people think of the S Corporation and the C Corporation in terms of how they are different. However, it is also helpful to understand the ways in which they are similar. This may help to make the decision of deciding between the two a little easier as there are advantages that both classifications provide.

Both the C Corporation and the S Corporation offer the same limited liability protection for shareholders/owners. By incorporating under either of these two structures you will still be protecting yourself from being personally responsible for the debts and liabilities of the business. The process of incorporating (for example, forming the appropriate documents required by the state) is the same regardless of whether you decide to have your business be an S or a C Corporation.

Both types of corporations have shareholders, directors and officers. In both cases the shareholders are the owners of the company and these owners are responsible for the election of the board of directors. Organizationally the two corporations are also the same in that the board of directors oversees and directs the affairs of the company and the directors elect officers to manage the daily affairs of the business. Both types of corporations are required to follow the same formalities internally and externally such as adopting bylaws, issuing shares of stock, and annual and shareholder meetings as well as the minutes of these meetings. They are also required to file the same appropriate annual reports required by each state and the fees associated with these reports.