Subchapter C Corporation: Everything You Need to Know
A subchapter C corporation is a type of business formation, although there are several others as well. When you're forming a business, choosing the right legal structure is an important step. 3 min read
A subchapter C corporation is a type of business formation, although there are several others as well. When you're forming a business, choosing the right legal structure is an important step. A business's legal structure will determine how taxes are paid on profits as well as which tax forms are required when filing tax returns.
The two most common business incorporation options are:
- S corporation
- C corporation
Beneath the C corporation umbrella is subchapter C corporation, which is a business taxed as its own legal entity, separately from the business owners. You might hear people refer to subchapter C corporations as corporations, C corps, or standard corporations. Based on information from the U.S. Small Business Administration, standard corporations may also be called C corporations. This is due in part to the Internal Revenue Code, Chapter 1, Subchapter C, which spells out the rules governing corporations and shareholders.
In order to qualify as a C corporation, the company must sell shares of its stock to shareholders, who will become company owners. All C corporations must pay taxes on all profits because they are considered separate entities. Big companies that trade on the stock exchange are C corporations.
An S corporation holds its own IRS special tax status. The name comes from the definition found in the Internal Revenue Code, Subchapter S. According to the IRS, S corporations must pass corporate credit, income, deductions, and losses on to shareholders for federal tax reasons.
S Corporation vs. C Corporation: The Similarities
One of the similarities between the two is the limited liability protection. This means that owners and/or shareholders aren't held personally responsible for liabilities and debts related to the business. Both C corps and S corps are created by filing within the state, which creates two separate legal entities.
The structure is similar as well, in that both options have officers, shareholders, and directors. The shareholders own the company and are responsible for electing the board of directors. The members of the board will manage all affairs and make decisions related to the corporation, but they don't manage the company's everyday affairs. The board of directors will choose and elect officers, who manage the day-to-day operations.
The corporate formalities are also similar. Both C corps and S corps must follow all external and internal obligations and formalities. These might include:
- Paying annual fees
- Adopting bylaws
- Filing annual reports
- Issuing stock options
- Hosting director and shareholder meetings
S Corporation vs. C Corporation: The Differences
Although there are quite a few areas in which C corporations and S corporations are similar, they also have some major differences.
Taxation is generally the biggest difference between S corporations and C corporations. Small business owners will assess the tax differences carefully as they decide which business formation option to choose. C corporations are taxable separately, with taxes paid at a corporate level with form 1120, a corporate tax form. When paying taxes on the corporate income, the business owner will first pay on the corporate level, and then again on dividends on the individual level.
On the other hand, S corporations are classified as pass-through entities for taxes. The owner will file federal form 1120S, which is an informational return. However, these corporation owners do not have to pay income taxes on a corporate level. Instead, business losses and profits are reported on the personal tax returns of the owners, which is referred to as passing through the business. All taxes due at the end of the year are paid by the owner at the individual level. Both corporations do require payment of personal income taxes on business dividends and any salary paid from the business.
Another difference is that S corporations do have ownership restrictions, while C corporations do not have those restrictions. An S corp is limited to 100 shareholders, and all of the shareholders must be current citizens and/or residents of the United States. An S corporation also can't be owned by another S corporation, a C corporation, a partnership, an LLC, or most types of trusts.
However, a C corp can be owned by an S corp. An S corporation is also limited to a single class of stock, which disregards voting rights. C corporations can hold multiple stock classes, offering more flexibility. This is helpful for business owners who plan to expand ownership, grow the business, or sell the company at some point.
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