S Corp Vs. Corp

By Mike Keenan

Incorporating a business creates a separate legal entity and protects shareholders with limited liability. However, a corporation can be either a C corporation or an S corporation. An S-corp is a C-corp that has made a special election. The differences relate to who can be a shareholder and how the company and shareholders pay taxes on the business's profits and losses.

Taxation Differences

C-corps face double taxation, which means that the corporate profits are taxed once at the corporate level and then a second time when the dividends are paid out to the owners. S-corp, on the other hand, are pass-through entities, which allows them to avoid double taxation. Instead, the profits and losses from the S-corp are reported on the shareholders' individual income tax returns each year, regardless of whether any distributions are paid out or not.

Shareholder Restrictions

S-corps have several significant restrictions on shareholders. First, an S-corp can't have more than 100 shareholders, although family members can be counted as just one shareholder for purposes of the 100-shareholder limit. Second, the shareholders must be U.S. citizens, U.S. residents or certain qualified trusts and estates. An S-corp can't have a partnership, corporation or non-resident aliens as shareholders. C-corps on the other hand, have no limitations on who can own stock or how many owners it can have.

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Share Restrictions

S-corps are also restricted to having just one class of shares. That means that an S-corp can't have one set of shares with higher divided payments or liquidation priority. However, an S-corp can have voting and non-voting stock without losing the election. C-corps aren't restricted as to how many classes of stock it can have, so it can have some shares that receive higher payouts, some with higher liquidation preferences and others with more control over day-to-day activities, if it so desires.

Business Types

Unlike a C-corp, S-corps can't engage in certain businesses. For example, certain financial institutions, insurance companies and domestic international sales corporations aren't allowed to be S-corps. In addition, if a C-corp elects to be treated as a S-corp more than 75 days after it starts, it could face extra taxes on the build-in gain in the company when it converts.

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Subchapter S Corporation Stock Regulations

References

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Advantages & Disadvantages of a C-Corp or S-Corp

The U.S. Tax Code and IRS recognize two different types of corporations: the C corporation and the S corporation. The two business types are taxed in two different ways. The C corporation pays taxes on its annual income and then its shareholders pay tax on any dividends they receive from the business. With an S corporation, the business does not pay any tax on its annual income. The shareholders are responsible for paying taxes on their share of the business’s annual income. As a result of this difference in how these organizations are taxed, C corporations and S corporations have different restrictions on several aspects of their business.

Subchapter S Corp Restrictions

Most people decide to incorporate their small businesses for the protection it gives them from personal liability for most business debts and obligations. The protection offered by operating a business as a corporation comes at a price. Corporate income is subject to double taxation: once when the corporation pays income taxes, and the second time when the shareholders pay income taxes on dividends they receive. Corporations that meet the restrictions for Subchapter S status can avoid double taxation. Income and losses of a Subchapter S or, as it is more commonly called, an S corporation, are passed through the corporation to the shareholders to be reported on their personal income tax returns, and the shareholders pay individual income tax rates that are lower than corporate rates.

Can an S Corp Have Two Classes of Stock?

An S corp cannot have two classes of stock. The IRS sets a number of requirements for S corporations, one of which is that the company have only one class of stock. Violating this requirement for your S corp, even accidentally, can have severe tax consequences both for your business and your personal income tax return.

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