S Corporations. C Corporations. Double taxation versus pass through abilities, unlimited number of shareholders versus a capped 100, and partnership tax benefits versus corporate tax incentives is behind that one single letter change. But just where is the line drawn between the similarities and differences of a business entity that started in the US during the 1790s (C Corp) and one that was enacted by Eisenhower in 1958 (S Corp)?
In this article, you’ll learn how the C Corp is double taxed, how many shareholders does the average S Corp have—it’s lower than what you think—and who applies for Subchapter C or S status: the big, multi-million dollar companies or small entrepreneurs?; (it’s not what you think). That and why you may want to conduct a Massachusetts entity search for corporate excise tax reasons.
One of the Biggest Differences
C corporations are taxed twice; S corporations are taxed once. This is perhaps the biggest difference between the two subchapters. And one of the reasons why S Corps are more corporate-partnership hybrid than pure corporation. Remember, on a federal tax level, S corporations are treated like partnerships while C corporations are treated like corporations?
So, S Corps reap pass through tax benefits normally associated with partnerships and LLCs, where the profits and losses are passed on (or through) to the shareholders who are personally taxed. A C Corp’s net income, meanwhile, is taxed once (roughly 34%) before it’s distributed to the shareholders who personally pay out approximately 20% per individual in taxes.
Shareholders: Unlimited Versus Limited
7, 52, 356, you name it—C Corporations can have an unlimited number of shareholders. Compared to their S counterparts, this makes up for the double taxation, especially considering that S corporations can only elect up to 100 shareholders maximum. But is this really a point against the S Corp? It depends. You see, according to Inc., only about 3% of S corporations have more than 3 shareholders, making 97% more or less having 3 shareholders tops. In regards to small businesses and entrepreneurs who normally file for a Subchapter S tax status, fewer shareholders may not be a hurdle assuming their setup is small and they’re not looking to rapidly grow in the next year or two.
Who Applies for Subchapter C and S Status?
Normally, C corporations are a popular choice for medium-sized to large companies looking to go public and expect rapid growth. These types of companies are searching for venture capitalists and other financial investors.
Created with the intent to give small businesses and entrepreneurs a leg up, S corporations are (usually) more for individuals who have financially surpassed sole proprietorships. They would loose out financially from that business entity versus forming or transitioning to an S Corp.
But… pipeline mega company, Enterprise Products Partners, L.P. and successful Wall Street firm, Kohlberg Kravis Roberts & Co. are the exception to these “rules.” These and other multi-million and multi-billion dollar companies are S corporations. Which goes to show that just because a business entity was intended for small businesses doesn’t mean only small businesses can only apply for it.
S Corp to C Corp; C Corp to S Corp
Companies aren’t locked into their business entity, even when incorporating. In general, it’s easier for a company to go from Subchapter S to Subchapter C. Businesses may first start out as a sole proprietorship to “get their feet wet” before turning to a more formal business structure, such as an LLC or S corporation. (Or several businesses pass this step altogether, immediately enjoying the pass-through tax benefits.)
S corporations and LLCs can also be a great business stepping stone because the losses accrued during the initial startup phase can be passed through to the shareholders without being taxed. Then, after making more profit, naturally the company progresses to a Subchapter C tax status. Going back to Enterprise Products Partners, L.P. and the other heavy hitting S corporations, we can now see how out-of-the-ordinary (and counterintuitive?) their business formation course was.
While businesses can switch from C Corp to a Subchapter S status, it’s not as easy. This is because the company is going from a non-pass-through business entity to a pass-through entity. The business may need to wait some years before it can successfully enjoy the pass-through benefits of an S Corporation. (It should also be noted that some C corporations looking to convert to an LLC, another pass-through entity, may face tax penalties.)
What They Have in Common
Partnership tax benefits aside, both the S Corp and C Corp are corporations. Meaning, these two entities have the same corporate structure, complete with officers and board directors. Since they operate in this capacity, mandatory records and meetings are a must. Being that the S and C corporations are treated as separate entities outside of the owner, owners and shareholders also enjoy limited liability protection. And, because they exist outside of the owner and shareholders, the business structure will survive long after the owner and/or shareholders leaves.
Look to The States
While the federal government treats the S corporation as a partnership, some states may in fact clump it with the C corporation. Or, according the Bloomberg BNA, add on additional requirements. The point is, state-wise, there is no uniform code of conduct in treating S corporations. For instance, in doing a Massachusetts entity search, you’d find on its secretary of state website that S corporations that have $6 million or more in receipts may have to pay the corporate excise tax. Although C corporations face similar challenges, it’s arguable there’s more continuity. For this reason, it’s important that you research your state’s laws on S corporations (and C corporations).
Conducting a Massachusetts Entity Search?
Or what about a Maine, Connecticut, or Rhode Island business entity search? Be sure to go to Sec State, an easy-to-use secretary of state database, which makes business and entity searches navigable and manageable. Within a few seconds, you can go from the California secretary of state page to Alaska’s secretary of state site.