As
you start your new business, one of the first decisions you will need
to put into writing is the business entity you wish to use. Today's
entrepreneurs have a variety of choices ranging from sole
proprietorships that are legally tied to the business owner to hybrid
structures to full-on corporations.
For
many new people starting out on this road, incorporating their
company as a separate entity provides the risk protection they need
and still allows full profit potential. But you will need to choose
between forming an S corporation and a C corporation. Which is right
for you? Here are some ways they are interchangeable and a few
important differences.
How
an S Corporation and C Corporation Are Alike
In
many ways, these two corporate entities are treated alike. They both
offer risk protection that separates the shareholders (partial
owners) from the business and limits shareholders' responsibility for
corporate debts and obligations. In both structures, you can receive
money either from the earnings and profits of the business or as an
employee of it.
The
legal filing responsibilities of both corporations are similar as
well. You would need to file incorporation paperwork with state
agencies and file additional documentation each year. The structures
of management and oversight are also the same, involving directors, a
board, and shareholder-elected officers to do the daily managing
tasks.
How
an S Corporation and C Corporation Are Different
So,
with all these similarities, what are the reasons to choose one type
or the other? Basically, these differences fall into two categories:
flexibility and taxation.
S
corporations are more strictly limited by rules. They cannot have
more than 100
shareholders
,
all shareholders must be U.S. citizens (and no C corporations), and
they can only have one class of stock. C corporations are not so
limited.
If
you plan to grow your business to a large scale, you may eventually
find these limits too restrictive. They may interfere with your
ability to raise capital — particularly venture capital — and
look for shareholders in creative places.
The
other primary difference is taxation. C corporations file their own
income tax return (Form 1120) annually and pay income taxes.
Distributions are generally paid as dividends and are taxed as income
of the shareholders who benefit from them. This is known as double
taxation, and it can be a drain on small businesses who have only a
handful or less of shareholders.
S
corporations are what is known as a pass-through entity. Like sole
proprietorships and limited liability companies, S corps don't pay
income tax at the business level. Instead, as with partnerships,
profits are distributed to the owners who pay income tax on that
personal income. This eliminates double taxation and frees up more
money for the corporation to use for growth.
A
pass-through entity distributes all profits to its ownership, whereas
a corporation can keep those profits for future use. If you plan to
reinvest much of the profits of your company for the foreseeable
future, a C corporation allows you to do this without increasing your
personal income taxes. You can still be paid for your work as an
employee.
What
You Should Keep In Mind
A
C corporation status is the default entity for tax purposes, but you
can always change to an S corporation structure at a later date. The
business keeps this designation only as long as everyone agrees and
it meets the rules. You can also change to a C corporation if you
find that the rules would be more beneficial.
Whether
you're still deciding on the initial business structure or your
company may benefit from changing structures, work with a qualified
business attorney in your area. At Donald
B. Linsky & Associate PA
,
we
can help. Our experienced business legal team can guide you through
the choices and help you pick the entity that will bring the most
profits and stability. Call today to make an appointment.
