There are two main classifications of for-profit corporations: S corporation and C corporation. Which is best for your unique business situation?
A for-profit corporation is a unique business entity, legally separate from its owners. Under a corporate structure, a business can deduct health insurance premiums and take advantage of other corporate benefits, whereas a sole proprietorship would not have this ability.
Under the corporate umbrella, there are two main types of for-profit tax classifications. There are pros and cons to each. To choose the best entity for your specific situation, it's important to look at all aspects of both a C corporation and S corporation.
First, let's take a look at some of the basic characteristics of a for-profit corporation.
As mentioned earlier, a for-profit corporation provides limited liability protection to its owners, except in cases of fraud or noncompliance with corporate regulations. The legal separation is known as the "corporate veil," and it protects the owners from being held financially responsible for the corporation.
A for-profit corporation raises capital by selling stock, which represents individual shares of the company to its shareholders. Then, corporate profits are distributed to the shareholders periodically in amounts proportional to the corporation's total number of authorized stocks.
When you submit your Articles of Incorporation to your Secretary of State's office, officially registering your business, you will by default form a C corporation. This is automatic, and it requires no additional forms specific to be submitted to either your state or the IRS.
A C corporation is a popular choice for larger corporations that intend to expand into foreign markets or bring foreign leadership into the company.
The ownership structure of a C corporation is quite flexible. Advantages of remaining a C corporation include:
· No limitation on the number of shareholders
· No restrictions on the citizenship of its shareholders
· Ability to issue multiple classes of stock
· Ability to own or be owned by other businesses
But in exchange for these benefits, there are drawbacks to this tax classification.
Disadvantages of remaining a C corporation include:
· Double taxation
In what is known as "double taxation," corporate income is taxed twice: first as corporate income and then again as individual income when profits are distributed to the shareholders.
An S corporation is generally a better choice for businesses that do not anticipate a great deal of expansion. However, there are certain forms that you can file at a later date if it becomes apparent that you would benefit from a different tax classification.
Drawbacks of an S corporation include:
· No more than 100 shareholders
· Shareholders must be either US citizens or residents
· Only one class of stock
· Cannot own stock in or issue stock to another company
However, an S corporation enjoys a more advantageous tax structure. One important benefit of an S corporation is:
· Pass-through entity
While a C corporation essentially pays taxes twice on its corporate income, an S corporation is referred to as a "pass-through entity" because there is no corporate income tax. Corporate income is taxed only once, on each shareholders' individual tax returns.
Which is best for me?
As an entrepreneur, it's important to have a basic understanding of your options; you don't want to jump into something, not knowing the restrictions and have it affect the potential growth of your company.
This decision is best reached with the input of your accountant, tax advisor, or corporate lawyer.