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C
Corporations and S Corporations
C Corporations
This is the most common type of corporation. Because C
corporations can have an unlimited number of shareholders,
it is the structure of choice for companies planning to have
a large shareholder base or publicly traded stock.
Unless a corporation qualifies for and chooses to be an S
corporation, it is automatically classified as a C
corporation. A C corporation pays taxes on its profits, and
files a Form 1120 with the IRS. Any excess profit is then
distributed to the corporation's owners, or stockholders.
These profit distributions are called dividends, and the
stockholders must pay income taxes on them. This is why it
is said that a C corporation results in "double taxation."
Notice that the corporation's profits are taxed twice: Once
at the corporate level, and again when distributed to the
owners.
Due to this double taxation, most small businesses are not
well served by being a C corporation. That said, there are
very limited circumstances where a C corporation can be used
by a small business owner in order to gain certain tax
advantages. Check with your tax advisor.
S Corporations
S corporations are corporations who elect to be taxed as a
"pass-through" entity (as if the owners were sole
proprietors or partners). All corporate profits and stock
dividends are reported by the owners as personal income.
This type of structure blends the tax advantages of a sole
proprietorship or partnership with the limited liability and
prestige of a corporation. Many small businesses elect this
status. To be eligible for this status:
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All shareholders must be citizens or permanent residents
of the United States ,
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The number of shareholders may not exceed 100,
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Only one class of stock may be issued,
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No more than 25% of gross corporate income may be
derived from passive income, and
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If held by a small business trust, the beneficiaries of
the trust must be individuals, estates or charitable
organizations.
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Banking institutions, insurance companies taxed under
Subchapter L and certain affiliated corporation groups
are ineligible.
Subchapter S of the Internal Revenue Code was created and
reworked by Congress late in in the 20th Century in order to
allow small business owners to incorporate without being
subject to double taxation. Thus, the "S corporation" was
born, and has been the preferred tax structure for small
businesses ever since (but see the section on LLCs below).
With an S corporation, the corporation files a Form 1120S
with the IRS, but the corporation does not pay income tax
(with a few rare exceptions). Rather, each owner pays tax on
her share of the corporation's profits, much like a partner
in a partnership. The difference here of course, is that
since it is a corporation under state law, there are none of
the legal liability problems associated with partnerships.
And since the corporation does not pay income tax, there is
no double taxation as there is with a C corporation. In
effect, it allows a corporation to be taxed like a
partnership. |
