Corporations are of two different kinds: the C corporation and the S corporation. If you're thinking of converting your sole proprietorship or partnership to a corporation, you will need to choose between these two.
Which is better usually depends on the aims and objectives you have for your business. Which way to go can be a bit tricky if you are unaware of both' salient features.
The similarities between the two are as follows:
- One of the significant similarities is the protection offered under the limited liability offer. Under this clause, the corporation's owners are not personally responsible for paying off the business's debts. So, the owners' personal assets (car, house, etc.) are saved from being seized and sold to pay off debts to creditors.
- For both the corporations to be brought into existence, state filing is required.
- Even if you incorporate your business into S or C-corporation, the articles of incorporation must be filed with the state. These are the essential formation documents of companies.
- Both corporations give full authority to the shareholders or owners regarding the election of a board of directors. Election of officers is then carried out to manage the daily affairs of the business. The Board of Directors generally only gets involved if there's a genuine need – such as in the cases of complex challenges and significant decisions.
- It's mandatory for both types of corporations to strictly observe the state's formalities and other authorities. Issuing stock, compulsory meetings of shareholders and directors, keeping corporate records, and adopting bylaws, are some of the basic internal formalities necessary for running an S-corporation and a C-corporation business. Paying annual fees, submission of annual reports, etc., are some of the external formalities that must be observed by both the corporations.
Some of the significant differences between the corporations:
- Corporate ownership. C corporations are allowed to have an unlimited number of shareholders, but this is not the S corporations' case. They can have at the most 100 shareholders, and they must be US residents. C corporations also cannot own them. Also, other S corporations, LLCs, or any other trust cannot own an existing S corporation. However, such restrictions are not imposed on C corporations. Also, C corporations are allowed to have multiple stock classes, which is not the case with S corporations.
- Taxation. S corporations need not pay taxes at the corporate level, although they need to file tax returns. Here, the business profits are transferred to the owners' individual tax returns, and so the taxes are paid at individual tax rates, which saves the S corporations from paying double taxation on the profits incurred. However, C corporations need to file a corporate tax return and report any profits or losses. These corporations, therefore, face double taxations as the profits are distributed among owners as dividends. These dividends have to be reported at an individual level.
- Election. Regular and timely filing of Form 2553 is mandatory for S corporations and must be submitted to the IRS.