An Overview Of Corporations – What Do The Prefixes ‘C-‘ And ‘S-‘ Mean When Someone Chats Me Up About Starting A Corporation?
A corporation is formed under the laws of a particular state with the filing of a formation document typically called a certificate (or articles) of incorporation from the secretary of state in that state. A summary of the general characteristics of a corporation are as follows:
Owners are one or more stockholders/shareholders
By-laws govern the corporation (in addition to the certificate/articles of incorporation)
Stockholders also typically enter into a stockholders agreement to set out agreements among them and voting frameworks
There are two basic types of stock of a corporation: common stock and preferred stock
Preferred stock will typically come with a dividend and other more favorable rights
Stockholders are typically not involved in the operation of the business – they elect a Board of Directors to manage the business
The Board of Directors controls the overall operation of the entity – Appoints officers and manages the overall direction and strategy of the business
The Officers then execute on the Board’s strategic directions and handle of its day to day matters
Certain major decisions are usually reserved for approval by the stockholders
The two types of corporations are C-Corporation and S-Corporations. Each, under state law, are simply corporations, however S-Corporations file an election with the Internal Revenue Service to be treated differently for tax purposes – which election triggers other unique characteristics/requirements.
C-Corporations pay what is called an “entity level tax,” meaning the entity itself is taxed on its operations. Any leftover funds can then be paid as a dividend to stockholders. The dividends paid by stockholders are then taxed again by the IRS, creating what is referred to as “double taxation” – two layers of tax imposed on the profits of a C-Corporation.
An S-Corporation elects to be treated by the IRS as a “pass-through” entity for tax purposes, which means it does not pay an entity level tax. Instead, the S-Corporation’s profits and losses generally pass-through to its stockholders who include their respective share of those items on their individual income tax returns. Based on making this election, S-Corporations have some limitations not applicable to C-Corporations.
S-Corporations can have only one class of stock
S-Corporations can have no more than 100 stockholders - and with certain limited exceptions, only US individuals (citizens or residents) can be stockholders
S-Corporations can only have one type of capital stock: common stock (no preferred stock allowed)
Before making a decision to form a corporation as the operating entity for a business, the founders of any company should consult with both legal and tax professionals to ensure that a Corporation (whether “S” or “C”) is right for their business. A false first step can cost the founders real dollars if the structure is not right for them.
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