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What is a corporation?

As a business owner, you will be faced with many important decisions, including what business structure to use in your company formation. There are four basic forms of business organizations in USA: sole-proprietorship, partnership, or corporation for business ownership, limited liability company. The form you choose will affect your ability to control and profit from the business, your business depends on your business goals and your personal style. This section gives you some issuers to consider, but it's also important that you review your situation with an attorney or a financial advisor.

What is a corporate company?

The most common form of business organization, and one which is chartered by a state and given many legal rights as an entity separate from its owners. This form of business is characterized by the limited liability of its owners, the issuance of shares of easily transferable stock, and existence as a going concern. The process of becoming a corporation, call incorporation, gives the company separate legal standing from its owners and protects those owners from being personally liable in the event that the company is sued (a condition known as limited liability). Incorporation also provides companies with a more flexible way to manage their ownership structure. In addition, there are different tax implications for corporations, although these can be both advantageous and disadvantageous. In these respects, corporations differ from sole proprietorships and limited partnerships.

There are two types of corporations for federal tax law purposes:

  • C corporations are what we normally consider "regular" corporations that are subject to the corporate income tax.
  • S corporations are corporations that have filed a special election with the IRS. They are not subject to corporate income tax. Instead, they are treated similarly (but not identically) to partnerships for tax purposes.

S corporation vs. C corporation: The similarities

The C corporation is the standard corporation, while the S corporation has elected a special tax status with the IRS. It gets its name because it is defined in Subchapter S of the Internal Revenue Code. To elect S corporation status when forming a corporation, Form 2553 must be filed with the IRS and all S corporation guidelines met. But C corporations and S corporations share many qualities:

  • Limited liability protection. Both offer limited liability protection, so shareholders (owners) are typically not personally responsible for business debts and liabilities.
  • Separate entities. Both the S corp and C corp are separate legal entities created by a state filing. 
  • Filing documents. Formation documents must be filed with the state. These documents, typically called the Articles of Incorporation or Certificate of Incorporation, are the same for both C and S corporations.
  • Structure. Both have shareholders, directors and officers. Shareholders are the owners of the company and elect the board of directors, who in turn oversee and direct corporation affairs and decision-making but are not responsible for day-to-day operations. The directors elect the officers to manage daily business affairs.
  • Corporate formalities. Both are required to follow the same internal and external corporate formalities and obligations, such as adopting bylaws, issuing stock, holding shareholder and director meetings, filing annual reports, and paying annual fees.

S corporation vs. C corporation: The differences

Despite their many similarities, S corporations and C corporations also have distinct differences.

  • Taxation. Taxation is often considered the most significant difference for small business owners when evaluating S corporations vs. C corporations.
    • C corporations. C corps are separately taxable entities. They file a corporate tax return (Form 1120) and pay taxes at the corporate level. They also face the possibility of double taxation if corporate income is distributed to business owners as dividends, which are considered personal income. Tax on corporate income is paid first at the corporate level and again at the individual level on dividends.
    • S corporations. S corps are pass-through tax entities. They file an informational federal return (Form 1120S), but no income tax is paid at the corporate level. The profits/losses of the business are instead “passed-through” the business and reported on the owners’ personal tax returns. Any tax due is paid at the individual level by the owners.
    • Personal Income Taxes. With both types of corporations, personal income tax is due both on any salary drawn from the corporation and from any dividends received from the corporation.
  • Corporate ownership. C corporations have no restrictions on ownership, but S corporations do. S corps are restricted to no more than 100 shareholders, and shareholders must be US citizens/residents. S corporations cannot be owned by C corporations, other S corporations, LLCs, partnerships or many trusts. Also, S corporations can have only one class of stock (disregarding voting rights), while C corporations can have multiple classes. C corporations therefore provide a little more flexibility when starting a business if you plan to grow, expand the ownership or sell your corporation.

Making the S corporation (S corp) election

To become an S corporation, you must file Form 2553 with the IRS. The IRS instructions—which can be a bit tough to follow—require that an election is considered effective in the current tax year only if the Form 2553 is completed and filed:

  • Any time before the 16th day of the 3rd month (for calendar year tax payers, this means it needs to happen by March 15th)
  • Any time during the preceding tax year (however, an election made no later than 2 months and 15 days after the beginning of a tax year that is less than 2½ months long is treated as timely for that year).

Generally, an election made after the 15th day of the 3rd month but before the end of the tax year is effective for the next tax year (unless you can show failure to file on time was due to reasonable cause).

Keep in mind that some states also require you to file a state-level S corporation election after incorporating your business.

General Corporation ( C Corporation )

Advantages
1. Owners' personal assets are protected from business debt and liability
2. Corporations have unlimited life extending beyond the illness or death of the owners
3. Tax free benefits such as insurance, travel, and retirement plan deductions
4. Transfer of ownership facilitated by sale of stock
5. Change of ownership need not affect management
6. Easier to raise capital through sale of stocks and bonds

Disadvantages
1. More expensive to form than proprietorship or partnerships
2. More legal formality
3. More state and federal rules and regulations

Close Corporation

There are a few minor, but significant, differences between general corporations and close corporations. In most states where they are recognized, close corporations are limited to 30 to 50 stockholders. In addition, many close corporation statutes require that the directors of a close corporation must first offer the shares to existing stockholders before selling to new shareholders.

This type of corporation is particularly well suited for a group of individuals who will own the corporation with some members actively involved in the management and other members only involved on a limited or indirect level.

Advantages of an S Corporation

  • Tax Savings. One of the best features of the S Corp is the tax savings for you and your business. While members of an LLC are subject to employment tax on the entire net income of the business, only the wages of the S Corp shareholder who is an employee are subject to employment tax. The remaining income is paid to the owner as a "distribution," which is taxed at a lower rate, if at all.
  • Business Expense Tax Credits. Some expenses that shareholder/employees incur can be written off as business expenses. Nevertheless, if such an employee owns 2% or more shares, then benefits like health and life insurance are deemed taxable income.
  • Independent Life. An S corp designation also allows a business to have an independent life, separate from its shareholders. If a shareholder leaves the company, or sells his or her shares, the S corp can continue doing business relatively undisturbed. Maintaining the business as a distinct corporate entity defines clear lines between the shareholders and the business that improve the protection of the shareholders.

Disadvantages of an S Corporation

  • Stricter Operational Processes. As a separate structure, S corps require scheduled director and shareholder meetings, minutes from those meetings, adoption and updates to by-laws, stock transfers and records maintenance.
  • Shareholder Compensation Requirements. A shareholder must receive reasonable compensation. The IRS takes notice of shareholder red flags like low salary/high distribution combinations, and may reclassify your distributions as wages. You could pay a higher employment tax because of an audit with these results.

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Reference:
http://www.investorwords.com/
http://www.bizfilings.com



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