What Is a Corporation?
A corporation is a type of business entity created by filing Articles of Incorporation with the state. A corporation’s owners are known as shareholders, and a corporation also has officers and directors who run the business. As a legal entity, a corporation is considered separate from its shareholders, meaning shareholders aren’t personally responsible for debts of the corporation (liability for shareholders is limited to their investment in the business). Corporations are subject to a number of legal requirements and “corporate formalities” to which other types of businesses are not.
The terms “C-corp” and “S-corp” refer to tax classifications that are available to both corporations and limited liability companies (LLCs). Corporations are taxed as C-corps by default, but some corporations can elect S-corp taxation instead. LLCs are typically taxed as sole proprietorships or partnerships, but they can also choose to be taxed as C-corps or S-corps.
The Basics of C-Corps
A C-corp is the most common corporate tax status. Like the S-corp, it gets its name from the subchapter of the Internal Revenue Code under which it’s taxed. Tax requirements are the key attributes that make a C-corp a C-corp and an S-corp an S-corp.
A corporate income tax is first paid by a C-corp with a federal return (Form 1120) required by the IRS. Shareholders must then pay taxes on personal income at the individual level for any gains from dividends or stock sale. This arrangement is referred to as “double taxation” because of the taxes levied on dividends at both the corporate and individual levels. C-corp shareholders are not allowed to write off corporate losses to offset other income on personal income statements.
C-corps are desirable because there’s no restriction on who can own shares. Other businesses and entities both in and outside the United States can hold ownership of a C-corp. There is also no limit to the total number of shareholders. C-corp shareholders are also afforded the full liability protections of any corporation.
The Basics of S-Corps
The most defining characteristic of an S-corp is the so-called “pass-through” tax structure it offers. S-corps are exempt from a federal corporate income tax—instead, income from dividends is taxed only at the individual level. This also means if shareholders can meet certain criteria, corporate losses can offset income from other sources. S-corps receive all the same protection from liability offered by corporation status as a separate entity.
A number of strict stipulations to operate as an S-corp can disqualify or disincentivize a business that might otherwise seek the status. S-corporations can’t exceed more than 100 shareholders, effectively ruling out corporations that want to go public. Ownership is restricted largely to individuals, who must also be citizens or permanent residents of the US, and to certain domestic trusts, estates and tax-exempt organizations.