There are several decisions to make when starting a business, which includes choosing a legal structure. In fact, it's crucial that you settle on a legal structure -- or business form -- prior to doing business. A few of the most common business structures are corporations, limited liability companies (LLCs), sole proprietorships, and partnerships, each with various benefits and downsides. The legal structure you choose for your business will determine the taxes it will be obligated to pay, in addition to personal liability and other factors.
Generally, sole proprietorships, LLCs, and partnerships enjoy pass-through taxation. A corporation, on the other hand, may have pass-through taxation or double taxation, depending on if it is a C corporation or an S corporation. This is because the Internal Revenue Code allows for two different levels of corporate tax treatment. Subchapters C and S of the Code define the rules that apply to corporate taxes. This article provides a basic summary of the tax differences between C corporations and S corporations.
The C Corporation
Corporations are a popular business structure because they provide the owners with limited protection from personal liability. The downside of corporations, however, are that they are more complex than other types of business structures and require observing several formalities in order to maintain corporate status. The C corporation is more common than an S corporation, mainly because it doesn't have the same eligibility requirements, and for the most part, when people refer to "corporations" they are referring to C corporations.
C corporations include most large, publicly-held businesses. These types of corporations face double taxation on their profits if they pay dividends. As the name suggests, double taxation refers to being taxed twice. In terms of corporations, profits are taxed at the corporate level and at the shareholder level. More specifically, corporations file their own tax returns and pay taxes on profits before paying dividends to shareholders, which are subsequently taxed on the shareholders' individual returns.
The S Corporation
The S corporation enjoys the same benefits and must observe the same formalities required of C corporations, but are not subject to double taxation. In order to qualify for subchapter S tax treatment, a corporation must meet the following requirements:
Additionally, after a business is incorporated, all shareholders must agree to subchapter S treatment prior to electing that option with the Internal Revenue Service. Please keep in mind that the limitations imposed by the subchapter may affect the transferability and marketability of corporate shares.
Get a Free Initial Case Review
If you would like help determining if a C or S corporation is right for your business, or you have any other questions about starting or operating a business, you could benefit from a consultation with a qualified tax lawyer. Professional assistance can make the difference between a solid and durable business structure and one that ends up exposing you to unintended liability. Contact a local attorney to arrange a free initial case review to learn how they can help you put together a corporate structure that best meets your needs.