the following article about the two types of corporations in the U.S., the c corporation (“C Corp”) and the s corporation (“S Corp”).
There are two primary differences between C Corps and S Corps, and these involve tax treatment and ownership. Large, publicly-traded companies are C Corporations because a C Corp can have an unlimited number of shareholders. S Corps, on the other hand, are limited to 100 shareholders and have restrictions on who or what may be a shareholder. C Corps are taxed at the entity level and the shareholder level – the double taxation you may have heard about. Whereas S Corps are ‘pass-through’ entities and distributions are taxed one time at the shareholder level. C Corps can have different classes of stock, such as preferred and common, whereas S Corps may only have a single class of stock.
C Corps and S Corps have many similarities, too, and at the time of formation, they are virtually the same. To create a C Corp or an S Corp, you must file Articles of Incorporation with the Secretary of State. Both types of corporations have shareholders, a board of directors, and officers who manage the day-to- day operations of the corporation. Both C Corps and S Corps offer limited liability protection to their shareholders – the liability shield for personal and other assets, and they both require corporate formalities to be followed such as issuing stock, completing annual renewals, conducting meetings, and maintaining corporate records. Historically, S Corps have been very popular for small to mid-sized companies with a limited number of shareholders and which meet the other requirements for the tax status. An S Corp becomes an S Corp by making an election to be treated as a pass-through entity; this election is done by filing a Form 2553 with the IRS in a timely manner (and that is generally within 75 days). The corporation can have up to 100 shareholders who must be either individuals, estates, some exempt organizations, or a certain type of trusts (qualified subchapter S trust or electing small business trust). Shareholders cannot be nonresident aliens or other ineligible corporations. Further, an S Corp must have one class of stock, use a calendar fiscal year, and the shareholders must consent to the election.
If you form a corporation and make no S Corp election, then the corporation will automatically be taxed as a C Corp. Despite their tax treatment, C Corps have advantages, and these include the ability to sell shares to an unlimited number of shareholders, whether from the U.S. or outside the U.S., who may be individuals as well as corporations, trusts, banks, and other types of investors. For this reason, investors such as venture capitalists are more comfortable with C Corps. Lastly, there are also some tax deductions available to C Corps that are not available to S Corps.
Nevertheless, it’s understandable why most small to mid-sized corporations have elected to be taxed as S Corps and avoid the unattractive ‘double taxation’. The new tax law passed late last year, which has become known as the ‘Tax Cut and Jobs Act of 2017’, reduced the graduated corporate tax rate from 35% to a flat rate of 21%. So, starting on January 1, 2018, C Corps will be taxed at a rate of 21% at the entity level. Distributions by C Corps to shareholders will still be taxed, albeit at the new lower income tax rates, so the ‘double tax’ was not eliminated. But now the corporate tax rate may be lower than the owner-shareholder income tax rate.
For small to mid-sized companies that are growing and retaining their earnings to reinvest in that growth, it may be better to be taxed as a C Corp at the 21% rate, so the recent changes in the tax laws should trigger a new analysis for corporations of any size. Any requests for topic suggestions may be sent to firstname.lastname@example.org. Although we cannot give you legal advice through the column, we can provide some general information that may be helpful for you to know. Our purpose is to educate and we hope that you can take something new away from this column each time you read it.