The Difference between a C Corporation and an S Corporation
Differences Between C Corps and S Corps Are Critical at Tax Time
The differences between a C corporation and an S corporation are fundamental, but these business structures share some common ground. They're entities set up for a variety of purposes, but most often they're created to engage in business. Corporations have been around since ancient times -- the word comes from the Latin "corpus" or "body." It's a separate legal entity from the people who are involved in operating it.
A corporation's owners are called shareholders. The activities of the corporation, including sales, revenues, expenses, assets and liabilities, are legally segregated from those of its shareholders. A U.S. corporation is set up by registering with the state in which it's located, but creating an S corp requires an additional step.
What is an S Corporation?
The term "S corporation" doesn't mean "small corporation." This type of business structure is named for Subchapter S of the Internal Revenue Code. An S corporation offers shareholders protection against the business's liabilities, but income is passed through to shareholders who pay taxes on it. Losses, deductions and credits also pass through to the owners.
After forming a corporation, you can then elect S corporation status with the Internal Revenue Service if you meet specific requirements: It must be a domestic corporation and have no more than 100 approved shareholders and can issue only one class of stock.
Differences Between a C Corporation and an S Corporation
A C corp is what you have if you do not elect S corp status with the IRS. Owners of C corporations have the same separation from liability as owners of S corporations -- because the activities of the corporation are separate, its liabilities cannot be legally transferred to its shareholders.
They cannot be sued on behalf of the corporation, nor are they personally responsible for debts it incurs. This separation is sometimes called a "corporate shield," but the shield can be pierced if an owner, board member or executive acts outside the bounds of the law or the duties and responsibilities of his office.
Taxation draws the most definitive line in the sand between S corporations and C corporations. Shareholders in a regular or C corporation may receive dividends or shares of the corporation's revenue, and they may sell their shares for a profit or loss. C corp owners have a double tax dilemma: The corporation pays taxes on its profits, and the owners are additionally taxed on the dividends they receive. Owners of a corporation who work in the business, typically in executive positions, are considered employees. They must be paid a reasonable salary and are also taxed on this personal income.
An S corporation does not pay dividends to its owners. The corporation files a tax return -- Form 1120S -- on which it shows its net profit or loss for the year, but this amount is "passed through" to the individual shareholders and reported on their personal returns even if it is not actually received by the owner in the form of dividends.
The S corp issues each shareholder a Schedule K-1, showing the amount allotted to him, and the shareholders must then report the income shown on the K-1 on their personal tax returns. This profit or loss is added to their other income and deductions.
The Bottom Line
Selecting a business type can be complicated. The information in this article is not tax or legal advice. Please discuss any decisions regarding your business status with both your tax advisor and attorney before making a decision.
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