Understanding S Corporation vs C Corporation Liability

As discussed in the previous article of this series, S Corporations and C Corporations are quite similar in that they both enjoy the advantages of separation of ownership and control. In addition, S Corporations are not taxed at the entity level; taxes on the income of the corporation are paid along with the taxes of the individual owners of an S Corporation.

One advantage of owning a corporation has to do with how liability is determined if the company is sued or ordered to pay a fine for some wrongdoing or noncompliance with local, state, or Federal Government regulations. Read on to learn how liability is the same and different in C Corporations vs S Corporations.

One of the major disadvantages of owning a sole proprietorship has to do with where liability lies. Sole proprietorship income taxes are claimed on the owner’s personal income taxes. This means that the Federal and most state governments do not distinguish between sole proprietorship income vs personal income; they are one in the same.

Similarly, these government entities also do not distinguish liabilities of the business and liabilities of the owner. In other words, the entire owner’s wealth is at stake while operating a sole proprietorship. Certainly, insurance and other options can limit how much the sole proprietor loses in the event of an unexpected liability, but there are no guarantees.

Corporations are treated much like a living person in that they can own property, enter into contracts, and must pay taxes. Dividends paid to owners of the company are subject to income taxes on the individual stockholder’s income taxes; this gives rise to double taxation and is one of the disadvantages of owning a corporation or part of it.

However, with some bad also comes some good. If the company is sued or found to be in non-compliance with some law or regulation, any payments from these events are the responsibility of the corporation as a “living” entity and not the responsibility of the owners or shareholders of the corporation.

Much like a C Corporation, liability lies with the “living” entity of the S Corporation. This means that the corporation is liable if sued or fined; liabilities of the company do not lie with the individual owners or stockholders. However, there is one caveat to liability with the S Corporation.

Suppose, for example, that a friend of yours owns stock in C Corporation XYZ and that the company is found to have illegally dumped toxic chemicals in the local water supply. Certainly, the liability and any damages caused by Corporation XYZ would be the responsibility of the company and not your friend. However, if the company is quite large, you wouldn’t look down on your friend for owning stock in a company for doing such as thing. He/she is far removed from the decisions of the managers entrusted to operate the company.

S Corporations, however, tend to be much smaller and owned by fewer investors, especially those S Corporations largely owned and operated by an entrepreneur. There is far less distance between the owners of the company and managers who run it. Stockholders in an S Corporation have a much greater proportional share of influence over how the company is run and who will run it in comparison to stockholders in a large C Corporation. Consequently, the owners of an S Corporation shoulder the stigma of any scandal, lawsuit, or fine much more so than owners of a C Corporation.

Although not financially liable for a lawsuit or scandal, owners of an S Corporation can be much more visible to the public than the millions of investors in a large C Corporation. The result can be some difficulty for S Corporation stockholders doing business elsewhere because of their ownership or dealings with ownership in the S Corporation. This can be a real factor when an investor is considering whether to invest in an S Corporation; he/she must often include the repercussions outside of just the financial losses associated with the liability of the S Corporation.

Although the liability of an S Corporation lies with the business entity itself and not the individual owners of the company, there are other issues to consider when investing in an S Corporation. Financially, the S Corporation is responsible for its business dealings because it is a “living” entity from a legal standpoint. However, being typically smaller than most C Corporations, S Corporations owners have to consider the ramifications of liability outside of just financial liability. Sometimes, other business dealings, trust, and reputation can be just as important as financial liability.