As business lawyers we are often asked about the differences between “C” Corporations and “S” Corporations. A “C” Corporation is the default choice for business corporations. Publicly traded corporations are “C” Corporations. Corporations provide shareholders protection from being held personally liable for a corporation’s debts in many situations. If the corporation is sued or files for bankruptcy, the shareholders are not held personally liable for the debts of the corporation (unless there are guarantees or extenuating circumstances). This is true whether you choose “C” or “S” tax treatment.
The difference between “C” and “S” Corporations is how they are treated for tax purposes. “C” Corporations are subject to the corporate income tax. If the “C” Corporation passes on some of its profits to shareholders in the form of a dividend, the shareholders are required to pay tax on that dividend. Therefore, any profits that are distributed to shareholders are taxed twice, once as income to the corporation and once as income for the individual shareholder.
“S” Corporations, on the other hand, are structured so that profits and losses “pass through” to the shareholders. Profits and losses in an “S” Corporation are not taxed at the corporate level, and instead are taxed only once as income or a loss for each individual shareholder. For example, shareholder #1 owns 50% of an “S” Corporation that has $50,000.00 profit this year. Shareholder #1 must declare $25,000.00 income on his personal income tax return. However, there are tax risks involved for shareholders of “S” Corporations in certain circumstances. If an “S” Corporation earns profits but does not distribute those profits to the shareholders, the shareholders are still required to report those profits on their personal income tax returns even though they did not receive any money. The time to choose “C” or “S” designation is when you incorporate. However, the IRS will sometimes allow late designations or changes in designation.
If you are considering starting a new business or are incorporating an existing business, consult a business lawyer in your jurisdiction about what business entity would be best for your business.