Incorporating a Small Business: S corporations versus C corporations

If you've been considering incorporating your small business, you've probably been confused about the difference between S and C corporations.

The similarities between S and C corporations are as follows:

1. Both S and C corporations are both separate legal entities that offer limited liability protection. If, for example, the corporation is sued only the corporation's assets are at risk. The assets of the board members or CEO are usually safe.

2. An S Corporation is essentially a C Corporation that has a special tax status with the IRS, created by filing form 2553. The articles of incorporation that are filed with the state are same.

3. Both entities must hold annual shareholder's meetings. Meeting minutes must be kept with the corporate records. Failure to follow this procedure can result in a judge's decision to 'pierce the corporate veil' and hold the corporation's owners personally liable for any penalties or debts.

So what are the differences?

1. S and C Corporations differ greatly with regards to taxation. With S corporations any income or loss generated by the business appears on the personal tax return of the owners. This is often referred to as a "pass-through" tax entity.

2. C corporations are often referred to as separately taxable entities. As you've probably already guessed, any gains or losses do not appear on the owner's personal tax records

By now you're probably thinking, "What's the use of an S corporation if my tax statements aren't kept separate?"

The reason is this: Dividends paid to the small business owners from corporate profits may be taxed twice. The IRS can tax both the corporation and the owner.

3. S and C corporations also differ with regards to ownership limitations, some of which are as follows:

a. C Corporations can have an unlimited number of shareholders while S Corporations are restricted to no more than 100 shareholders. As a small business owner this shouldn't be much of a problem.

b. S corporations cannot have shareholders that reside outside of the United States. Practically anyone can own shares of a C corporation, regardless of where they reside.

c. Also, S Corporations ownership is largely restricted to individuals. C Corporations, other S Corporations, LLCs, partnerships and many trusts cannot own shares of an S corporation. C corporations can sell shares to individual or other legal entities.

Well there you have it. Basically S corporations offer the same liability protection without the tax separation or freedom of ownership. The restrictions placed on S corporations are hardly noticed by the bulk of small businesses with only a few owners. If you're still not sure what type of corporation to form, there's a lot more information about incorporating a small business at small-business-assistance.com

Jacob Wren operates Small Business Assistance - a resource site for entrepreneurs that offers advice on incorporating and an array of other small business topics.