C Corp vs. S Corp Battle Royale

I've had several people ask me recently (clients and others) about the difference between the two corporation types and realized it might be a good idea to take a moment and explain the basics of their differences.

Corporation Basics

In its most basic form, a corporation is a legal entity that exists independent of its creators and owners. One person or a group of people could create a corporation and, over time sell off their interests to others. But, until the corporation is dissolved, it still exists and operates. The Supreme Court has even gone as far as saying corporations are 'individuals' for the purpose of making campaign contributions. The long and short of it is that a corporation is a created entity that operates according to whatever the statutes allow it to do; whether that is running a business, offering a service, investing in other companies, or even donating to political campaigns.

C Corporation

Generally when people talk about a corporation, this is what they're talking about. The regular, relatively standard corporate structure with officers, directors and stockholders. They're a business. You buy and sell stock, and the publicly traded corporations are the ones whose performance is measured by the NASDAQ and Dow Jones.

You were probably expecting some checklist or something, but truthfully there isn't much to explain as far as what it is. At least, not for our purposes here. The difference comes when you talk about an S corporation...

S Corporation

This is where things change. An S corporation relates to how the entity is taxed (for most small businesses it's very beneficial) and as a result there are some limitations on who can participate in the creation and operation of one. Without those limitations, multi national billion dollar corporations would get even more benefits than they already do tax-wise. So what are those rules? * No foreign shareholders * No corporations as shareholders * No more than 100 shareholders * Have only one type of stock

There are a couple more requirements, but they're more specialized and would take some amount of explanation without really applying to most situations.

So what do you get for fitting into these requirements?

Without the filing of paperwork, all corporations are assumed C. If you make the S corporation election with the IRS then you get pass through taxation. This means that whatever profits and losses the corporation has, its shareholders divide them up and put them in their personal income tax returns. This also means that all corporate distributions are only taxed once since the corporation itself does not pay taxes, but instead the shareholders pay in their personal tax returns. For a smaller company or a company with few shareholders, this could be a great situation.

Why Wouldn't You Use an S Corporation?

The S corporation status might be amazing for many situations, but not for all. For example, if your corporation is not domestic or your shareholders are in other countries, it does not work. Additionally, for a startup company that plans on getting venture capital investment, having one class of stock doesn't cut it. VC's always require a special class of stock just for them which gives greater voting power so they can have some control over the company they just put a million dollars into.

I could keep going with all sorts of reasons why one might or might not choose the S corporation election, but it could to on I forever. The truth is that to really know what you should do, it's best to seek the advice of an experienced and knowledgable attorney who can help sort through the details of your business and see what works best for you.

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