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Should You Incorporate?
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Article 5: Types Of Corporations
Beyond the question of whether or not to incorporate, you must also decide which type of corporation is best for you. There are two types of corporations to choose from:
C corporation — Unless a company elects otherwise, it will be treated as a C corporation (or standard business corporation) when incorporating. C corporations may have an unlimited number of shareholders and may issue various types of stock (e.g., common, preferred). S corporation — Companies may instead elect Subchapter S status by filing IRS Form 2553 when incorporating. S corporations may issue only one class of stock and are limited to 75 shareholders, all of whom must elect S status unanimously.
For most small businesses, the main benefit of S status is that S corporations are taxed in much the same way as partnerships, with income and losses passing through directly to the shareholders. This avoids the potential double taxation of C corporations, where income is taxed once at the corporate level and again at the individual level when it is passed through to shareholders in the form of dividend income.
Gene Fairbrother, the lead micro-business consultant for the National Association for the Self-Employed (NASE), says that the decision to incorporate — and, if so, whether to choose a C or S corporation — is primarily a tax issue: “It has nothing to do with the size of your business and everything to do with the amount of your profits.”
Fairbrother adds that “the myth of the C corp is that you’ll be taxed twice, but advance tax planning can eliminate this double taxation.”
Other things to consider when weighing C versus S status are:
The deductibility of certain items like company-paid health insurance for the principal and his or her family (deductible for a C corp, but not an S corp) The potential tax ramifications of the conversion from a C to an S corp The limitations on S corps with regard to number of shareholders and class of stock
Also, non-U.S. residents can be shareholders of a C corporation, but not an S corporation. And S corporations cannot be owned by C corporations, other S corporations, many trusts, LLCs or partnerships. C corporations are not subject to these restrictions.
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