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C Corporations or S Corporations?

July 3, 2018

As we’ve previously discussed in these blog post, entity selection is a very important matter, one which requires a careful analysis of all relevant facts and circumstances. Choosing an entity that isn’t ideal for a situation can have negative financial consequences, so it’s imperative that the best entity be chosen. In this blog post, our New York City tax attorneys discuss entity formation; specifically identifying and discussing the highlights and some of the key differences between a C corporation and a S corporation.

Among those without formal training, the term “corporation” is typically a loose definition.  It includes practically any type of business entity with multiple members.  Many laypeople would consider a partnership, limited liability company, or other small business entity to be corporations.  None of these entities, though, are properly referred to as a corporation by a legal practitioner.

In fact, among tax attorneys, CPAs and other specialists, the term is seldom used by itself without further clarification.  When used by a specialist, however, the term “corporation” usually refers to either one of these two business entities. As we will see, these two entities, though similar in some ways, have a number of significant differences which can impact their desirability in a given context. Let’s go over exactly what makes each of these entities unique and then provide some tips for making the proper selection. 

Subchapter C Corporations

In many ways, a an entity formed under Subchapter C of the Internal Revenue Code is the “default” corporation. They are the entities people conceive of when they hear the word “corporation.” When you form one by filing articles of incorporation with a state government, you will create a C corporation unless you later make a specific election otherwise. As an entity, a C corporation offers certain advantages to business people who are seeking to further their business agenda. For one thing, a C corporation can have an unlimited number of shareholders; this differentiates C from S corporations, and it allows the C corporation to expand its business more easily, as it can recruit any number of new investors.  

The shareholders of a C corporation own a slice of the underlying business and also have liability protection. This means that the shareholders are not liable for debts incurred by the corporation. Shareholders of a C corporation receive dividends from corporate profits, which means that they receive a portion of the profits consistent with their ownership percentage. As we’ve discussed before, dividends are unique to a C corporation, as S corporations and other small business entities distribute income to shareholders but do not give “dividends” as such. 

Arguably the most salient feature of C corporations is the way they are taxed. C corporations are subject to “double taxation,” which means that the income they generate is taxed once at the federal corporate tax rate, and then again when that income is sent to individual shareholders in the form of dividends. This double taxation of the C corporation is one of the main drawbacks of these entities and a big reason why some business people choose, instead, to create a S corporation.  

The S Corp 

S corps are quite literally “small business corporations”.  That is, they are corporations which have elected to be taxed like partnerships and other small business entities. S corporations therefore have the benefit of pass-through taxation.  It means that all of the income generated by the S corp passes through directly to the individual shareholders.  As a result, it’s reportable on their individual returns. Hence, unlike C corps, a S corp isn’t subject to double taxation, and for this reason is the preferred choice for many business people. However, S corporations can issue only one class of stock, whereas C corporations can issue multiple classes of stock. This gives C corps an advantage over S corps, in this respect, as C corps can offer investors different classes of stock depending on the circumstances.  

S Corporation Issues

S corporations can only have 100 shareholders; this makes intuitive sense.  It is a small business entity by definition.  Think about it.  It makes logical sense that they would have some type of ceiling on the number of possible shareholders. This shareholder ceiling is important when a person decides to make an entity selection.  After all, S corporations won’t be eligible to become publicly traded. Accordingly, if business growth is related to size, then electing S status may be inadvisable.

Ultimately,then, it’s clear that each of these entities has its own strategic advantages.  The advantages depend on the situation, though.  Therefore, it’s up to business owners to make a thorough account of pertinent facts and make an informed choice. Think about it.  Maybe owners want to take advantage of pass-through taxation.  Nonetheless, they maybe can deal with the limitations of S elections.  In that case, taking the S Corp route may be the best decision.  Maybe, though, owners want more room for expansion.  If so, and they can handle the double taxation of C corps, maybe the C corp route might be better. 

NYC Tax Attorneys Can Help You

C and S corporations aren’t usually tops on most people’s favorite activities list. Memorizing the tax implications of either certainly isn’t.  But we do.  That’s clients like that about us. So why not give us a try?  Our top NYC tax attorney spend their professional time concentrating on difficult matters like these.  That way, our so that our clients don’t have to worry about them. If you have a question about the tax consequences of selecting an entity, contact us.  If you have questions about any other business or tax issue, contact us again.  Here at Mackay, Caswell & Callahan, P.C., we’ll give you assistance right away. 

Image credit: Anthony Easton

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