If you have decided to go the corporation route for your business, your main two options are to register either as a C corporation (C-Corp) or an S corporation (S-Corp), which allow to protect stockholders from the corporation’s debts and liabilities.
While a C-Corporation is the traditional and most common type of corporation, the S-Corporation has increasingly become the preferred form for many small businesses.
What is a C Corporation?
A C Corporation is a business which is a completely separate entity from its owners, unlike a partnership, so it must file its own taxes and be responsible for its dealings. It can have unlimited numbers of shareholders, and those shareholders can be any kind of legal entity.
Additionally, since corporations are taxed on their income and shareholders have to claim dividends as taxable income themselves, shareholders of a “C” corporation are double taxed on their dividend income.
Advantages of a C Corp
- Low tax rate on the first $75,000 of business income.
- C corporations can sell stock or shares (common or preferred) with no limit to the number of shareholders.
- Better fringe benefits for owner-employees, such as the opportunity to use a medical reimbursement plan.
Disadvantages of a C Corp
- Double taxation: The profits of the corporation are taxed as they are earned at a corporate level, while shareholder are also taxed when the profit is distributed out as dividends.
- Tax traps for accumulated earnings and personal holding companies.
- Annual income in excess of $75,000 is taxed at a high corporate income tax rate.
What is an S Corporation?
Much like a “C” corporation in that it is also its own legal entity, protects its shareholders from legal liability, and requires a certain amount of yearly maintenance. However, an “S” corporation allows shareholders to claim their share of the corporation’s income directly on their personal tax return, avoiding a double tax situation. However, an “S” corporation is generally limited in the amount of shareholders.
Advantages of an S Corp
- Unlike C Corporation, Income is taxed only at the shareholder level, not at the corporate level, avoiding double-taxation.
- In many cases, an S Corp offers owners protection from lawsuits or responsibility for the debts of the corporation.
- S corporation does not have double taxation: the corporation doesn’t pay income tax; the owners pay income taxes based on their respective shares of the profits.
Disadvantages of an S Corp
- Shareholders that control and own a significant amount of or majority of the voting stock have a dominant voice in the management of the business.
- Cannot have more than 100 shareholders, which reduces the chances of raising capital.
- Strict Qualification Requirements: Only individuals, certain estates and trusts, certain tax-exempt organizations can be shareholders.
The bottom line
Choosing the right entity type for your company is critical from a legal and tax perspective but ultimately, your decision may depend largely on your business type and goals.