What is the best legal structure for your business? While there is an assortment of different structures (corporation, limited liability company, partnership, etc.), it is first important to understand the difference between an S-corporation (“S-corp”) and C-corporation (“C-corp”).
An S-corp is a corporation that elects to be taxed under Subchapter S of the Internal Revenue Code. The profits (and losses) of an S-corp flow through the entity, and the shareholders are taxed at the personal level. On the contrary, a C-corp is taxed on its profits as a taxpaying entity, and the shareholders are taxed again when dividends are distributed. While this “double taxation” may not seem appealing, there are some advantages for larger corporations. For example, the income of an S-corp may bump the shareholders into a higher tax bracket, resulting in higher tax liability. However, a C-corp can withhold dividend distributions to shareholders to avoid this. This option is not available for an S-corp because the profits automatically flow through to the shareholders.
Despite the differences in taxes, S-corps and C-corps are quite similar. They are both separate entities from the shareholders, subject to federal and state securities laws, protect shareholders from liabilities of the corporation (if managed correctly), require filing documents with the Secretary of State, have a Board of Directors and officers, and must observe corporate formalities. Directors and officers have responsibility for the management of the business, and most decisions must be approved by the Board in a formal meeting or written document. On the contrary, shareholders generally are not entitled to actively participate in management.
S-corps have many restrictions. They cannot have more than 100 shareholders, all shareholders must be U.S. citizens or resident aliens, and certain trusts and tax exempt entities cannot be shareholders. S-corps can also only have one class of stock. However, C-corps provide flexibility through various classes and series of preferred stock (stock that permit preferential voting rights and distributions to the owners). Therefore, C-corps are more appealing to investors and are best if there are plans for an Initial Public Offering (IPO) in the future. Unlike a C-corp, non-taxable fringe benefits (group health insurance, accidental or death benefits, etc.) are generally not excludable from the owner’s income or deductible by an S-corp. Shareholders who work for an S-corp may be treated as self-employed, rather than a W-2 employee (as with C-corps). In this case, they are not entitled to many benefits, such as health and death benefits.
When choosing a legal structure for your business, it is important to consider all aspects and consult with your Certified Public Accountant and attorney. If you have any questions about forming a business entity or any other business law matter, please contact the Law Offices of Tyler Q. Dahl for a free consultation.
Disclaimer: This material was prepared for general informational purposes only, and is not intended to create an attorney-client relationship and does not constitute legal advice. This material should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction. You should always consult a qualified attorney regarding any specific legal problem or matter.
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