If you’re filing articles of incorporation for a business, chances are you’ve done a lot of research on what type of business structure is going to best fit your plans. If you’re filing as a corporation, you’ve likely come across two very specific types of corporations: a C corporation and an S corporation.
If you’re confused, don’t worry—they’re two sides of the same coin. Understanding what makes them different, however, can help you make decisions about how you want to run your corporation.
Similar, yet different
C corporations and S corporations actually start out the same: as a C corporation. The default status of any corporation is C. A corporation only becomes an S corporation in the event that all shareholders vote to do so. And, after making the transition, the structure of the business stays relatively the same—the only real change involves the way the business is taxed and the flexibility of the ownership.
One of the known drawbacks of a C corporation is in how it’s taxed. Because the business is taxed at the corporate tax rate and any dividends issued are further taxed at the personal income level, there’s a situation known as “double taxation.”
S corporations, on the other hand, are not taxed at a corporate level. Instead, profits and losses are distributed among shareholders and taxed as such at the personal income level. This strips the double taxation anomaly away and, in most cases, guarantees a lower taxation rate.
Because there’s such a dramatic difference in how C and S corporations are taxed, there are also stipulations in how these businesses can be structured as well. Some examples include:
- C corporations are allowed to divvy up voting rights based on different classes of voting shares; S corporations are not and can only have a single share structure for equal voting rights across shareholders.
- S corporations are not allowed more than 100 voting members, therefore, are not allowed to issue more than 100 shares of stock. Moreover, all shareholders must be U.S. citizens. C corporations, on the other hand, have no restrictions on the number of shares that can be issued and shareholders can be global.
- There are also several types of business that are not permitted to file for S corporation status. These include insurance companies, banks and other financial institutions.
Understanding the pros and cons
As with any decisions made during incorporation, it’s important to think about the future of your business and what your ultimate goals are. If, for example, you’re planning on an IPO in the future, a general C corporation is the best option. On the flipside, if you’re looking to avoid double taxation and have a core group of shareholders, an S corporation filing may be the better decision.
When in doubt, consult with an accountant, attorney or business advisor on what your vision for your company is and which corporation type is best suited to help you achieve that reality.
Steven K. Hardy is an attorney in the Corporate, Tax & Estate Planning Practice Group at BoltNagi PC, a full service business law firm serving the U.S. Virgin Islands.