In a previous blog, our Colorado business lawyer discussed how to incorporation and the distinction between an “s” and “c” corporation. Here we will look at the differences between a c and s.
A subchapter “s” corporation is purely for relatively small business entities. Under federal tax law, in order to take advantage of the “s” corporation’s pass through taxation, the corporation MUST MEET ALL OF THE FOLLOWING QUALIFICATIONS
i. The corporation must be a “domestic” corporation meaning that it has to be incorporated in one of the 50 states;
ii. All shareholders must be human beings and not other business entities (there are some limited exceptions to this that are rarely applicable to small corporations);
iii. There may be no more than 100 shareholders;
iv. All shareholders must be U.S. citizens or resident aliens;
v. There can be only one class of stock (so all shareholders are treated equally); and,
vi. You must apply for subchapter s status using IRS form 2553 no later than 2 months and 15 days (and not 75 days) after you have first become a corporation.
If you meet all of the above, then the profits and losses of the corporation are passed directly through to each shareholder in proportion to his or her percentage ownership of all of the shares that have been issued to shareholders.
By default and under federal tax law, if you do not timely file to become a sub s, or if you file but you do not qualify, you are a subchapter c corporation.
As noted in a previous blog a subchapter c corporation is subject to double taxation (once when the corporation receives revenue, and again at the shareholder level if the corporation issues dividends). There are advantages however to being a subchapter c.
i. You can be a domestic or foreign corporation;
ii. Shareholders can be other business entities as well as being natural persons;
iii. There is no limitation to the number of shareholders;
iv. The shareholders can be business entities or natural persons;
v. There can be any number of classes of stock;
vi. There is no filing requirement as by default you are a c corporation.
The tax rate on a c corporation may be more advantageous for the corporation in terms of cash flow and tax planning. For instance, the corporation can set up various accounts into which it can “store” its cash (e.g. a building acquisition account), and may avoid immediate taxation because of it.
For the most part however, small businesses choose to become a subchapter s corporation if the decision is made to be a corporation over a LLC.