Corporations are subject to noticeably more state regulations during the formation as well as operation. The corporation is an entity created by filing Articles of Incorporation with the appropriate state authorities. This gives it legal existence & the right to carry on business. After this adoption of corporate bylaws (internal operation & management rules) is the first thing that is generally done by the corporation.
C-corporation & S-corporation are the common types of corporations. The prefixes refer to the chapter in the U.S. Tax Code, which outline the way the specific type of corporation needs to be taxed. On the state level C-Corporations & S-Corporations are the same, they abide to the same laws & regulations. The type S is a choice given by the IRS for small corporations in order to be taxed differently than regular corporations. Other than that, organization & operation of the 2 types is generally similar.
A simple organizational structure of a corporation has the levels mentioned below:
• Shareholders: shareholders own shares of the corporation; they elect directors of the corporation & vote on major corporate matters. Shareholders as legal entity do not directly manage the corporation. That said the person that is a shareholder can be say the president of the corporation as well, and the president can be directly managing it.
• Directors, who may be one or more of the shareholders, are responsible for making major business decisions, which includes appointing officers as well. As a director, you don’t own any of the business.
• Officers, who may be one or more of the shareholders, are responsible for day to day operation of the corporation. Officers generally consist of the president, vice-president, secretary, & treasurer. As an officer, you don’t own any of the business.
- difficult organizational structure. Every level is restrained by the above level, for this reason a certain degree of individual control is lost
- additional expense & burden of detailed recordkeeping
- the initial fees of formation are more expensive compared to those of a sole proprietorship or partnership
- greater government regulation
- double taxation, first tax at the corporate level & second when the profit is distributed to the shareholders at the personal level. Dividends are not deductible as a business expense, therefore the profits are being taxed first at corporate level, and once distributed to the shareholders, shareholders are being taxed again at personal level
- limited liability of the founders & investors . The liability for corporate debts is generally limited to the amount of money each shareholder contributed to the corporation. The potential risk is losing what you have invested
- a corporation can have a lasting existence. Unlike other business types, death of a shareholder generally does not dissolve the corporation. This is important for establishing long-term business relationships.
- a shareholder of corporate stock may freely sell, trade, or give away the share (some restrictions may apply). This offers the investors with liquidity to shift assets & owners with ability to raise capital when needed.
- depending on the business & the way it is operated, the way corporations are taxed can be an advantage, instead of being a disadvantage. Corporations can set aside excess earnings (up to certain levels) without distributing it to the shareholders.
- ability to offer employee & officer benefit programs, available for corporations only
- various retirement, stock option & profit-sharing plans are only open to corporations
The S-corporation, also known as Corp-S, is a type of corporation created by the IRS (Internal Revenue Service) for specific tax purposes. The reasoning is allowing small corporations to be taxed like a partnership, at the Federal level, if they prefer so. This gives the small corporations the opportunity to reap the benefits of the corporation, without double taxation. For all other purposes S-corporation & C-corporation are similar.
Obviously, the IRS has certain requirements to qualify for the S type:
- not more than 75 shareholders
- the shareholders generally must be individuals & citizens of the US
- must have only one class of stock
- shareholders must consent to S-corporation status
- an election of S-corporation status must be filed with the IRS
Taxation for S-corporation shareholders is handled the same way as for partners in a partnership. All the shareholders are being taxed once at the individual level, thus avoiding the double taxation. In addition shareholders of S-corporations can personally deduct any corporate losses. All the other advantages or disadvantages are the same as for C-corporations.