The Difference Between "S" and "C" Corporations
What’s the difference between an “S” corporation and a “C” corporation? Simple. It’s the way the business entities are taxed.
An S corporation is subject to the provisions of Subchapter S of the Internal Revenue Code, and C corporations are taxed under Subchapter C of the code.
Both types of corporation are created by filing articles of incorporation with the Secretary of State, after which the shareholders must decide which tax structure they’ll choose. After those initial steps, things get more complicated.
A Study in Contrasts
The S corporation is subject to the taxing provisions in much the same manner as a partnership. The S corporation files an information tax return, Form 1120S, to report its income and expenses, but it is not separately taxed.
Income (including, if certain requirements are met, capital gains) and expenses of the S corporation flow through to the shareholders in proportion to their shareholdings, and profits are taxed at the shareholders’ individual tax rates.
For Minnesota purposes, the S corporation also pays a minimum fee, based on its Minnesota-sourced property, payroll and sales.
The C corporation, on the other hand, is a separate taxable entity. The C corporation reports its income and expenses on a corporation income tax return and is taxed on its profits at corporate income tax rates. Dividends distributed to the shareholders are taxable income to the shareholders.
In contrast, all the income of an S corporation is taxable income to the shareholders whether or not the income is distributed to the shareholders as dividends.
An S corporation is defined by statute as a domestic corporation (i.e., a corporation organized under the law of one of the states of the United States) which:
- Does not have more than 100 shareholders
- Does not have any non-individual shareholders (other than estates, certain trusts, and certain tax exempt entities)
- Does not have a nonresident alien as a shareholder
- Does not have more than one class of stock.
Certain corporations by statute are ineligible for S corporation status. If the corporation qualifies for S corporation status, the shareholders must formally choose to be so treated for tax purposes. This is accomplished by filing Form 2553 with the Internal Revenue Service on which all shareholders consent in writing to have the corporation treated as an S corporation. The election must be made in a timely manner, as prescribed by the Internal Revenue Service.
The election is valid for the taxable year for which it is made, and for all succeeding taxable years of the corporation, until the election is terminated. Statutory procedures determine how the termination is accomplished.
In general, S corporation status is terminated when it is revoked by vote of the shareholders, or when the corporation no longer meets the statutory criteria for S corporation status. S corporation status also may be terminated when passive investment income (income from interest, rents, royalties, dividends and the like) exceeds a certain statutorily defined threshold.
Because of the possibility that S corporation status may be inadvertently terminated, persons planning to establish an S corporation are strongly encouraged to consult in advance with legal and tax counsel in order to properly structure the corporation and its capitalization.
In some cases, forming a limited liability company may better suit the owners’ business and tax objectives.
Consultants at our Small Business Assistance Office can help you understand more about S and C corporations or other types of business organizations. And our network of Small Business Development Centers has experts located in nine main regional offices and several satellite centers statewide.
Our Guide to Starting a Business in Minnesota provides a detailed look at this and other important issues.