C or S Corporation: What's the Legal Difference?

You may have heard your accountant talk about it: What's the difference between an S Corporation and a C Corporation?

And more importantly, why does this difference even matter?

Let's take some time to talk about the key differences between the two, while briefly explaining the whole idea of entity choice.

The main reasons why the S-Corp versus C-Corp distinction matters are easily summarized as follows:

• They're taxed differently.
• There are certain restrictions in stock ownership for S Corporations.
• C Corporations have fewer restrictions on ownership.

Taxes

There are really two ways than an entity can be taxed. One is as a pass-through entity and the other is as a corporation. What's the difference? Well, for starters, a pass-through entity is taxed like a partnership. The income flows down to the partners. It's only taxed once, to the partners.

An S Corporation can actually make a choice as to how it wants to be taxed. It can choose to be taxed as a pass-through entity or as a corporation. All it has to do is make the "S-election," which is done on a tax form.

If the entity is taxed as a corporation, it's taxed once at the corporate level and then again at the shareholder level, once the proceeds are distributed (think dividends).

Ouch. Who wants to be taxed twice? Well, that depends. If it makes strategic sense for you to form a C Corporation, then you might just have to face the consequences of being double-taxed.

Strategic Reasons

Not everyone can be an S Corporation. S-Corps are limited to no more than 100 shareholders. They are also limited to one class of stock. This makes it very difficult for startups that might be seeking angel funding or venture capital, since many times, those relationships are dependent on the creation of different categories of stock.

To sum it all up, a small entity that plans to stay in the hands of the same original founders is generally better off as an S-Corp; a corporation that plans to get venture funding or go public one day is typically better off as a C-Corp. But because each entity's situation is different, you'll want to consult an experienced business lawyer to figure out the best structure for your business.

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Related Resources:

• C or S Corporation Choice is Critical for Small Business (Forbes)
• What is an S Corporation? What are its Benefits? (FindLaw's Free Enterprise)
• Potential Benefits of Choosing to Be Taxed as an S-Corp (FindLaw)