A Comparison of S Corporations and C Corporations

Incorporating a business involves an analysis of the purpose of incorporating and the advantages of creating this type of business entity. Matching the business entity type to the needs of the pending organization and its owners is crucial to avoid costly mistakes down the road.

Among the choices of business entities, Corporations offer some distinct advantages over other organizational forms such as sole proprietorships and partnerships. Unfortunately, not all businesses can function effectively within the main business types. The S Corporation is an example of a business entity that shares some of the advantages of the C Corporation and some of the flexibility of other business types.

The C Corporation is so called because it is taxed under Chapter 1, Subchapter C of the Internal Revenue Code. Like S Corporations, C Corporations are considered to be “living” entities that may own property, enter into contracts, and are liable for damages caused to individuals, other business entities, and governments. In fact, the term “corporation” is derived from the Latin word “corpus” which literally means “body.”

Both types of corporations enjoy separation of ownership and control which means the managers of these two types of organizations act as the agents of the stockholders, the real owners of the company. In addition, both types of corporations free the owners from liability. Liability lies entirely with the corporation itself, not owners of shares of stock.

To remain as either an S or C Corporation, the organization must have in place a process for electing a board of directors, hold annual meeting, and produce an annual report. Unlike sole proprietorships and some partnership, both S and C Corporations enjoy perpetual terms. This means that the corporation goes on “living” regardless of whether an owner sells his/her stock (ownership) in the company and whether or not any individual dies or quits. This is in direct contrast to a sole proprietorship in which the company ceases to exist at the time of death of the owner.

There are, of course, some distinct differences between S and C Corporations. One important difference has to do with how the organization and its owners are taxed. A C Corporation is taxed just like an individual; its income is taxable just as if it were a living entity. If a C Corporation pays dividends on its share of stock, the dividends are then taxed again as personal income of the shareholders.

Unlike the C Corporation, the S Corporation is not taxed at the entity level. Any income passed on to the shareholders is taxed only on the individual shareholders personal income tax filing. In this way, double taxation is avoided.

Transferring ownership of a C Corporation is as simple as selling shares of stock to someone else who wishes to invest in the corporations. Transfer of ownership of an S Corporation is similar except that there are restrictions on who may own shares of stock in the company. There are no such restrictions for C Corporations.

Both C and S Corporation can take on debt or sell stock to raise capital for operations. However, Corporations may not buy stock in an S Corporation. This restriction is in place partly so that a C Corporation may not masquerade as an S Corporation, enjoying all of its benefits but avoiding the taxation of the company at the corporate level.

The S Corporation is really a business entity that exists to allow business owners and entrepreneurs the opportunity to enjoy some of the benefits of a C Corporation without several disadvantages such as taxation at the entity level and double taxation. One major advantage of the S Corporation is that liability resides at the corporate level and does not transfer to personal liability on the part of the S Corporation’s shareholders, the owners of the company. For more on S Corporation liability, read the second article in this series.