Definition of S Corporation and C Corporation: Everything You Need to Know
The definition of an S corporation and C corporation only differs slightly, yet these two types of business structures are unique.3 min read
2. What Is a C Corporation?
3. What Is an S Corporation?
The definition of an S corporation and C corporation only differs slightly, yet these two types of business structures are unique. A C corporation is essentially a standard corporation, whereas an S corporation is a business that has elected a special tax status. This allows the business to become a "pass-through entity," avoiding taxation at the corporate level. Before you select the structure that is right for you, it is imperative that you understand how they compare.
When starting a small business, many owners do not realize that they need to choose a business structure before they can begin making any profit. In terms of changing a business entity, the most common options are choosing to form a C corporation or an S corporation. Which you choose will solely depend on your business goals.
In a corporation, owners are referred to as shareholders. From these shareholders, directors are selected in order to oversee the company's operations. Those who focus on the company's day-to-to day operations are known are officers, and are hired by the business director(s). When there are multiple shareholders, profits or "dividends" are distributed based on owned shares.
- Issue stock
- Create corporate by-laws
- Hold annual meetings for both directors and shareholders
- Keep minutes of these meetings
- Issue formal, written documents when key decisions are made
- File reports on an annual basis
- Pay all required annual fees
If a corporation fails to complete the tasks above, they may experience the loss of personal liability protection and the corporation may formally end. In contrast, as long as a corporation meets all of these requirements, shareholders will not be personally liable for corporate debts.
What Is a C Corporation?
All corporations start as C corporations. In order to convert into an S corporation, a C corporation must file Form 2553 with the IRS. Basically, unless you become an S corporation, you will form a C corporation by default. As long as you are eligible, you can then convert to an S corporation at any time. Since corporations are owned by shareholders and are viewed as separate legal entities, they benefit from liability protection. This means that they are not personally responsible for corporate liability or debt.
If you would like to form a C corporation, you must file the appropriate documents. In the majority of cases, this will be your Articles of Incorporation. As mentioned above, once you are up and running, you must then comply with all other corporate requirements.
What Is an S Corporation?
In comparison, an S corporation differs slightly from a C corporation. If you are operating on a calendar year basis, you will need to file Form 2553 no later than March 15th in order to operate as an S corporation. This form can also be filed at any time during the previous tax year.
The key difference between these two types of corporations is their tax status. The "S" component comes from Subchapter S of Chapter 1 of the Internal Revenue Code. Structured the same as a C corporation, an S corporation also enjoys liability protection. In fact, these two types of corporations are really more similar than they are different.
Each state has unique laws in terms of the formation of an S corporation. You may even find that your state does not recognize this business entity. Therefore, you will benefit from S corporation status at the federal tax level, yet will still be treated as a C corporation within your state.
When looking at the big picture, the most significant difference between S corporations and C corporations is in terms of taxation. In turn, S corporations save money, as they do not need to pay any taxes at the corporate level. If you currently own a C corporation, you may want to consider conversion if it makes sense for your business. For those who are unsure, it is recommended that you seek a professional opinion prior to any major changes.
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