There are two types of corporations, C and S corporations, and C corporations are the “regular” type. Their primary differences lie in the way they are taxed; otherwise, they are very similar. We’ll get to the distinguishing features of each, but here are some common denominators.
The main advantage of being a corporation is the personal liability protection it offers; debt is considered that of the corporation rather than its owners, thus shareholders’ personal assets cannot be seized to satisfy it.
Typically, owners of corporations are shareholders (“shareholder” and “owner” are thus used interchangeably in the context of corporations) and each receive stock certificates. But not all owners of corporations are shareholders, as there are some corporations that don’t issue stock. Nonprofit corporations are nonstock, and there are also nonstock corporations that are for profit.
Shareholders of a corporation can have different percentages of voting power.
Shareholders elect a new board of directors each year. Directors lead company affairs, select officers, and approve transactions.
Directors are not responsible for the oversight of the corporation’s day-to-day operations; that’s the duty of officers. In most states, three officer positions are required to be held: a president, secretary, and treasurer.
A single shareholder of a for-profit corporation is typically permitted by state corporation laws to hold all three officer positions and be the sole director simultaneously.
Further, in small corporations, it is possible for one person to function as the sole shareholder, director, and officer.
While there must be one shareholder meeting per year, it isn’t required for a board of directors meeting to be held annually, as each board member can simply sign off on resolutions.
They perpetuate in the case of the death or disability of one of their shareholders or after being sold by a shareholder.
Corporations are more expensive to operate and must comply with more regulations than other business structures.
Regular corporations are called “C” corporations because the general tax regulations governing them are located in Subchapter C of Chapter 1 of the Internal Revenue Code.
A C corporation is an individual legal entity, separate from its owners.
They can issue both common and preferred stock. Preferred stockholders have a higher claim to a company’s assets and earnings, with a predetermined dividend that is usually larger than that of common stockholders’ dividend that varies based on the company’s earnings. While common stockholders can vote on company matters, preferred stockholders cannot. In the case of bankruptcy or company asset liquidation, however, preferred stockholders get their money back or redeem shares before holders of common stock.
A disadvantage of being a C corporation is that some of their earnings are subject to double taxation: Earnings are subject to corporate federal and state income taxes, of which the dividends portion (paid to shareholders) is subject to a secondary taxation on shareholders’ personal income tax returns.
Corporations must file Form 1120, U.S. Corporation Income Tax Return. Shareholders employed in a corporation pay income tax on their wages, and the corporation and employee each pay one-half of payroll taxes (social security and Medicare), for which the corporation may take a deduction. Any dividends received by a corporate shareholder require income tax payment, which payment may render the shareholder eligible for a dividends-received tax deduction.
C corporations must also file taxes quarterly.
C corporations are not limited in their number of shareholders.
S corporations, called “S” due to the location of the general tax regulations governing them in Subchapter S of Chapter 1 of the Internal Revenue Code, are attractive to small businesses in that they offer the liability protection of a regular C corporation along with additional tax benefits.
Because an S corporation is not considered a separate legal entity as is the case with a C corporation, earnings are taxed just once; income and losses are “passed through” to owners and included on their individual tax returns. They are taxed similarly to partnerships.
S corporations must file Form 1120S, U.S. Income Tax Return for an S Corporation. They only are required to file once per year, whereas C corporations must file quarterly.
S corporations can only issue a single class of stock. However, the stock must only offer identical rights to distributions and liquidation proceeds, not identical rights in voting; the company can issue voting common stock and nonvoting stock so long as it meets those basic requirements.
They are limited to 100 shareholders, making them more suitable for smaller businesses. Shareholders also must be U.S. citizens or residents as well as natural persons; corporations and partnerships are not eligible shareholders.
In order to be designated as an S corporation, a business must file Form 2553, Election by a Small Business Corporation, but normally status as a C corporation must first be attained, and it must be a corporation formed in the U.S.
Limited liability companies (LLCs) also have the option of being taxed as an S corporation, in which case an LLC would continue to be legally considered as such but would operate like an S corporation in tax terms. Articles of incorporation must be filed with the Secretary of State in the state in which the LLC is to be formed.