Corporation
A corporation is an artificial legal person that carries on business through its officers and directors for the benefit of its shareholders. In most states, one person may form a corporation and be the sole director, officer, and shareholder. The corporation carries on business in its own name and shareholders, officers, directors, and employees are not personally liable for its acts (except in very specific instances). Most entities that intend to raise capital for long-term growth form a corporation. Corporations work well because their structure allows for a wide variety of financing options and there is a continuity of existence. When a corporation is young or has few assets, a lender may require the majority shareholder, the directors, or the principal officers of the corporation to personally guarantee a corporate debt.
An S corporation is a corporation that has filed Internal Revenue Service (IRS) Form 2553, electing to have all profits and losses pass through to the shareholders under Subchapter S of the Internal Revenue Code rather than being taxed at the corporate level. An S corporation files a federal income tax return on Form 1120-S, but pays no federal or state tax. The profit shown on the S corporation tax return is allocated on a prorated basis according to stock ownership, and is then reported on the shareholders' personal tax returns.
If you plan to raise capital, be aware of a number of restrictions placed upon S corporations. First, an S corporation may only issue one class of stock and it can only have up to one-hundred shareholders. Those shareholders will primarily be individuals, because S corporations cannot be owned by C corporations, other S corporations, many trusts, LLCs, or partnerships. In addition, S corporations may not have any shareholders who are nonresident aliens. If an S corporation were to violate any of these rules, it would lose its S corporation election and be taxed as a C corporation.
A C corporation is any corporation that has not elected to be taxed as an S corporation. A C corporation pays income tax on its own taxable income under Subchapter C of the Internal Revenue Code and files a federal income tax return on Form 1120. Thus, when dividends are paid to shareholders, they are taxed twice—once at the corporate level and again by the shareholders. Recent tax law changes favorable to shareholders have, in part, mitigated this tax burden.
State Taxes: In most states, a C corporation must also pay state corporate income taxes.
Unlike S corporations, C corporations have no restrictions on the number or types of shareholders, and they may also have multiple classes of stock. Classes of stock generally consist of common stock, which is voting stock, and one or more classes of preferred stock. Preferred stock is generally nonvoting, but usually has first preference to receive declared dividends and a preference in payment in the event of liquidation. When the board of directors of a C corporation defines the preferences of a particular class of preferred stock, the corporation must generally file those preferences with the state prior to issuance of the preferred shares.
