Comparison of S corporations and C corporations
The Following Applies to All Corporations:
- A corporation is an artificial being created by state law. In other words, it is a creature of the state.
- A corporation is a separate legal entity, separate and apart from it owners (called stockholders or shareholders).
- Although a corporation does not have a physical presence, it does have a board of directors to set the direction and policies of the organization and corporate officers to carry out the policies and run the day-to-day operations.
- Examples of what a corporation may do include:
- Enter into contracts, sue and be sued, have a bank account in its name, and be a partner in a partnership.
- A corporation's name is signed by corporate seal.
- Stockholders receive limited liability protection which insulates their personally owned property against the claims of corporate creditors.
For more about the legal aspects of a corporation, see Ten Attributes of a Corporation.
- From a legal standpoint, a C corporation and S corporation are the same. The distinction between a C and S corporation is in how C and S corporations are taxed under the Internal Revenue Code (IRC).
- The C and S refer to the sections (subchapters) of the Internal Revenue Code.
- C corporations file Form 1120.
- When corporations are initially formed, they are subject to IRC rules under subchapter C - Corporate Distributions and Adjustments .
- After initial incorporation, an election may be made to be taxed under subchapter S - Tax Treatment of S Corporations and Their Shareholders instead of subchapter C.
- The election is made by filing Form 2553 with the IRS.
- Once the election is approved by the IRS, the C corporation is converted to an S corporation.
Note: The legal status of the corporation is not affected by an election to be taxed as an S corporation. The laws of the state of incorporation still apply.
- A C corporation is a tax-paying entity; it pays taxes on corporate income. In other words, income is initially at the corporate level.
- C corporation Income that is not distributed to stockholders is called retained earnings.
- C corporation income distributed from retained earnings to stockholders is called dividends.
- C corporations stockholders pay taxes on dividends distributed to them from retained earnings.
- Net income of C corporations is subject to double taxation, first at the corporate level, then, if distributed to shareholders as dividends, at the individual level.
- C corporation dividends are reported to shareholders annually on Form 1099-DIV. The IRS also gets a copy of this form.
C corporation Losses
- Net losses incurred by a C corporation are deducted from corporate income of other periods; they do not pass through the entity to its stockholders.
- Capital losses of C corporations may only be deducted from corporate capital gains and not from regular corporate income.
- Unlike the capital loss treatment for individuals, where capital losses in excess of $3,000 may only be carried forward, capital losses of C corporations may be carried back three years and forward five years. See Capital Gains and Losses for C corporations for more information.
An S corporation is generally not taxed at the corporate level because it is a pass-through entity. However, there a some exceptions where an S corporation may be subject to income taxes at the corporate level. These exceptions generally apply to older C corporations that were operating for several years before converting to S corporation status. Newly formed S corporations are not subject to these exceptions and therefore, are never taxed at the corporate level..
- An S corporation is treated as a partnership for federal tax purposes. This means, like a partnership, an S corporation is a tax-reporting entity and not a tax-paying entity (with the exceptions referred to above).
- An S corporation files Form 1120S to report income, expenses, gains, losses, and credits.
- Income, deductions, gains, losses, and credits pass-through the S corporation directly to its shareholders who report these items on their individual income tax returns.
- Schedule K-1 is issued annually by the S corporation to each shareholder reporting their share of income, deductions, gains, losses, and credits.
S corporation Losses
Losses incurred by an S corporation pass-through the entity to its stockholders who may deduct their share of the loss against their other sources of income reported on Form 1040.
- Return to the Tax Basics for Startups Table of Contents to find related links.