Picking the Right Structure for Your Business

Starting a business means making dozens of choices both big and small. One of the most important choices you will make is how you will structure your business entity. Two of the most common options are the S corporation (S corp) and C corporation (C corp).

If you don’t understand the difference between the two, you’re not alone. Many budding entrepreneurs ask questions about which business structure they should choose. And yet it’s one of the most important decisions you’ll make about your business.

C Corporations are the standard corporation, whereas the S corporation takes advantage of a special IRS tax status. S corporations are so named because they are defined by Subchapter S of the Internal Revenue Code. IRS Form 2553 must be filed to elect S corporation status and all S corporation guidelines must be met.

How S Corps and C Corps are Similar

C corps and S corps share many of the same qualities, including:

  • Legal entities. Both C corps and S corps are legal entities created by filing documents with the state. Formation documents, which are usually called articles of incorporation or certificates of incorporation, are the same for both types of corporations.
  • Limited liability. Both corporation types offer limited liability protection, which means owners (shareholders) are normally not personally responsible for business liabilities and debts.
  • Corporate structures. As a corporation, both C corps and S corps have shareholders, officers, and directors. Shareholders (owners) elect the board of directors who oversee corporate affairs but are not responsible for day-to-day operations. These directors elect officers to manage daily business affairs.
  • Corporate obligations. Both C corps and S corps must adopt bylaws, issue stock, hold owner and director meetings, file annual reports, and pay annual incorporation fees to the state.
  • Personal income taxes. With both types of corporations, personal income tax is due on any salary drawn or dividends received from the corporation.

How S Corps and C Corps are Different

There are also distinct differences between S corps and C corps:

  • Taxation. Normally considered the most salient difference between C corps and S corps, taxation will probably be your primary consideration when you elect which type of corporation to form. C corps are separate tax entities, which means they file a corporate tax return (using Form 1120) and pay corporate taxes. If income is distributed (either in the form of salaries or dividends), this is considered personal income and is taxed as such. This means income is taxed twice: first when corporate taxes are paid and second at the individual level as dividends or salaries. S corporations are considered pass-through tax entities. This means they file IRS Form 1120S for informational purposes, but no income tax is paid at the corporate level. Any profits or losses are instead passed through the business and reported on the shareholders’ personal tax returns. Taxes are paid at the individual level by the owners and there is no double taxation.
  • Ownership. S corps are restricted to no more than 100 shareholders whereas there are no restrictions on the number of owners of C corporations. Also, S corp owners must be United States citizens or residents. Furthermore, S corporations can’t be owned by C corps, other S corps, LLCs, partnerships or many trusts. Finally, C corporations can have many classes of stock, while S corps can only have one class of stock. This means that if your business might need to offer various classes of stocks as it grows and matures, a C corp might be the more strategic choice.

If you are starting a business, consult an experienced business attorney to help you decide which kind of business entity is right for you. At the Lusk Law, LLC, we handle everything from business formation to employee contracts to complex business litigation. We can advise you every step of the way, so you can focus on your business.

Maryland Association of Paralegals

On September 18, 2018, Lusk Law’s paralegal, Anne Wolf, was a featured presenter at the Maryland Association of Paralegal’s MAP U#5, held at the Community College for Baltimore County.…