Comparing C and S Corporations

One of the biggest choices a small business owner can make is the choice of business entity. For most people the choice comes down two a choice between and LLC and a corporation. Tax benefits often make forming a corporation the better choice. When forming a corporation, the client still must choose between a C Corporation and an S Corporation. This article will discuss some of the differences and similarities.

Similarities:

• By default, all new corporations are C Corporations when initially forms. An S Corporation is simply a C Corporation that files IRS form 2553 to elect to become an S Corporation.
• They both are separate legal entities that are created by filing Articles of Incorporation with the Secretary of State. The offer the same personal asset protection. The shareholders are generally not personally responsible for the debts and liabilities of the corporation.
• Both types of corporations must follow they same formalities. Each They must hold annual meetings of shareholders and directors each year and meeting minutes must be kept with the corporate records.

Differences

• The S Corporation is a pass-through tax entity – this means that the income or loss generated by the business is reflected on the personal income tax return of the owners. A Corporation is a separately taxable entity. The profits and losses are taxed directly to the corporation. This can lead to double taxation on dividends that are paid out of corporate profits to the owners.
• The ownership of an S Corporation is restricted; however, the C Corporation does not possess these same limitations.
• The C Corporation can have an unlimited number of shareholders while a subchapter S Corporation is restricted to no more than 100 shareholders.
• Non-US residents can be owners of a C Corporation while an S Corporation may not have non-US residents as shareholders.
• S Corporations cannot be owned by C Corporations, other S Corporations, many trusts, LLCs, or partnerships. C corporations are not subject to these restrictions.
• The S Corporation must make a timely election of S Corporation status. The IRS instructions indicate this form must be completed and filed at any time before the 16th day of the 3rd month of the tax year the election is to take effect or at any time during the tax year preceding the tax year it is to take effect. An election made no later than 2 months and 15 days after the beginning of a tax year that is less than 2½ months long is treated as timely made for that tax year. An election made after the 15th day of the 3rd month but before the end of the tax year generally is effective for the next tax year. However, an election made after the 15th day of the 3rd month will be accepted as timely filed if the corporation can show that the failure to file on time was due to reasonable cause.

Your legal counsel should work with the client's tax adviser to the determine whether or not to make Subchapter S election. The information provided in this article is general information only and is not intended as legal advice. DO NOT use this information as a substitute for obtaining qualified legal advice or other professional help. Please contact us at (619) 448-2129 or e-mail us for a consultation.

About the Author: Carl H. Starrett II has been a licensed attorney since 1993 and is a member in good standing with the California State Bar and the San Diego County Bar Association. Mr. Starrett practices in the areas of bankruptcy, business litigation, construction, corporate planning and debt collection.