In my previous post, I reviewed the differences between the Limited Liability Company (LLC) and the S Corporation. There’s another popular business structure, the C Corporation (or C Corp). And understanding its components and the differences between a C and S Corporation is critical to making the right decision for your business structure.
For a quick refresher, incorporating your business can convey some key benefits. Most importantly, it protects the private property of the individual owners from any liability of the business. Additionally, your CPA or tax advisor may have advised you that you can lower your tax burden by forming a corporation. Or, in some industries, your business may need to have a legal corporate structure for you to be awarded a major contract.
For tax purposes, there are two types of corporations: the C Corporation and S Corporation. The C Corporation is a legal entity. There are strict requirements to form and dissolve it — a corporation continues indefinitely beyond the life of its owners unless dissolved. A C Corporation can earn money, take out loans and be sued (again, this is a major benefit, since liability shifts from the owners to the corporation itself). And because the C Corporation is its own entity, ownership may be easily transferred via the sale or distribution of stock certificates.
In actuality, every corporation starts off as a C Corporation when the documents are first filed. Then, soon after incorporation (or to get technical…within 2 months and 15 days), all shareholders must submit Form 2553 to the IRS to become an S Corporation. This means the company is now treated as a pass-through entity, and income/loss is passed through to each shareholder’s individual tax statement.
This is a critical difference. Unlike the other popular forms of business (namely the S Corp and LLC), a C-Corp is not a pass-through entity. It is taxed separately and the company must file its own tax returns. C-Corps have their own tax brackets, which depending on your situation, may be lower than individual tax rates.
When it comes to reinvesting your profits, you should take particular notice. As pass through entities, individual owners of an S Corporation or LLC are liable for any taxes owed on profits — whether that money is reinvested back into the company or put in their wallet. In essence, if I own 50% of an S-Corp and that S-Corp makes $80,000, then I need to report $40,000 in income on my personal tax return. And it doesn’t matter whether that $40,000 actually ended up in my pocket or was used to purchase a new server and other equipment for the business.
With the C-Corp, this isn’t the case. Individuals are taxed only on the money they actually receive. Therefore, if you’re planning on reinvesting your startup’s profits back into the company, a C-Corp is preferred.
Of course, there are other differences between the C-Corp and the S-Corp, including:
- An S-Corp cannot have more than 100 shareholders. With a C-Corp, there’s no limit on the number of shareholders. Obviously, if you anticipate having more than 100 shareholders, the C-Corp is the way to go.
- All shareholders in an S-Corp must be individuals (not LLCs or partnerships) and legal residents of the United States. This is not the case with a C-Corp.
- A C-Corp lets you create different classes of stock, so owners can have different shares in terms of profits and losses.
Additionally, the C-Corp is generally the preferred business structure for startups seeking funding from different sources, including VC and equity financing.
Historically, small business owners were discouraged from forming a corporation because of legal complexities, difficulties in corporate filings, and extensive corporate formalities. Today, the incorporation process has been simplified and the costs of incorporating a business are comparable to that of filing a DBA or sole proprietorship.
Keep this information in your back pocket as you get the ball rolling on your business venture, and good luck!
Nellie Akalp is the CEO & Co-Founder of CorpNet, Incorporated, her second incorporation filing service company based on the simple philosophy of truth in business and her strong passion to assist small business owners and entrepreneurs.