Corporations are the oldest and most popular entity individuals choose to organize and conduct business under. The main benefit of a corporation is that as an owner of the business you can limit your personal liability for the debts and obligations of the business. The major types of corporations in place today are distinguishable by the manner in which they pay income tax.
- C Corporation – The C corporation is a separate entity from you as the owner and as such must pay income taxes on its net income.
- S Corporation – the S corporation is a separate entity from you as the owner, however under the law you may file an election under subchapter S of the Internal Revenue Code and elect to taxed as a partnership with pass through taxation as a disregarded entity.
Important aspects of a corporation are:
- Formation – A corporation is formed by filing the appropriate documentation with the state. Additionally, bylaws must be prepared that set forth the rules and procedures for the governance of the corporation.
- Ownership – A corporation is owned by the shareholders who hold the stock as evidence of their ownership. While a c corporation may have an unlimited number of shareholders with different classes of stock, an S corporation is limited to 100 persons, can issue only one class of stock and is generally available only to individuals as shareholders subject to a few exceptions.
- Management – A corporation is governed by its board of directors who are elected by the shareholders. The board appoints officers, typically a president, vice president, treasurer and a secretary, who are responsible for the managing the corporation pursuant to policies set forth by the board. Shareholders do not participate in the day to day affairs unless they are also a director or officer.
- Personal Liability – As a shareholder generally, you are not personally liable for the debts and obligations of the business which is the primary reason many choose to operate as a corporation. However, should you fail to maintain the corporation as a separate entity from yourself or fail to follow the formalities required by law then you could lose the protection and find yourself fending off a creditor who is claiming you are personally liable for a debt. Furthermore, personal liability can attach if you guarantee a debt, receive an improper distribution or engage in tortious conduct.
- Taxation – Because a corporation is a separate entity from yourself the corporation must pay income taxes before distributing any of the profits. Then, as the profits of the corporation are paid to you as the owner/shareholder in the form of dividends the income is taxed again on your personal income tax return. This form of double taxation can be eliminated if you elect to be taxed as an S corporation. By doing so, the profits are “passed through” to you and are taxed once on yours and other shareholders personal returns. The C corporation must pay state income tax as well as a minimum franchise tax. The S corporation must pay greater of 1.5% income tax or $800 minimum franchise tax.
By choosing to operate your business as an S corporation you are able to take advantage of the combined benefits of pass through taxation and protecting your personal assets from the debts of the business.