Several types of corporate entities exist in the U.S. The common corporate types are the C- Corporation, S-corporation, and Limited Liability Company (LLC). C-corporation is the most common business entity type and its shareholders are not personally liable for the debts and obligations of the corporation. The S-corporation is another type of corporation that files IRS form 2553 to elect a special tax status with the IRS. This allows the S-corporation to become a "pass through" entity-meaning that the income or loss generated by the business is reflected on the personal income tax return of the owners. The LLC provides limited liability for its members and owners, similar to how a Limited Partnership provides for its Limited Partners or a corporation provides for its shareholders. The choice of legal entity is a difficult issue and must be addressed on a case-by-case basis, depending on the type of business to be conducted, the goals of the owners, the prospect of the business development, and the financial arrangements.

A C-corporation has the ability to issue stock or stock options to attract employees or investment, and it is a good entity form to go public when there is such a need in the future. The C-corporation may ordinarily deduct the entire value of the fringe benefits offered to shareholders who also serve as employees. Unlike an S corporation, there is no limit on the number of shareholders and shares may be held by people who are neither citizens nor residents of the United States. There can also be advantages to the C-corporation in its flexibility to carry corporate losses forward to future tax years.

In some circumstances, corporate profits will be subject to "double taxation", first as corporate income and second as income to the ultimate recipient, the shareholders. For instance, if a corporation issues dividends from its profits, it has already paid income tax on that money, but the dividends also remain taxable as income to the shareholders. Also, the C-corporation cannot pass through losses to investors, as can an S-corporation or LLC.

Almost every state requires the incorporator to submit Articles of Incorporation to form a corporation. The Articles of Incorporation shall include, at the least, the name of your corporation, its address, the resident agent’s information, the business scope, the names of the directors of the corporation and other related information.

The corporation needs to be run in a business-like way in order to retain benefits such as limited liability. This includes investing money in the corporation, formally issuing stock to shareholders, regularly holding meetings of directors and shareholders and keeping minutes of their major decisions, making sure that corporate officers and directors sign documents in the name of the corporation, maintaining separate bank accounts from the owners, keeping detailed financial records (separate from the owners’) and filing a separate corporate income tax return.

Corporations require more paperwork than other business types such as LLCs and sole proprietorships. Some examples are:

• Minutes of shareholder and director meetings.
• Documentation of important decisions.
• Corporate tax returns.
• Double-entry bookkeeping system for transactions.

Because it is a separate legal entity, a corporation such as a C-corporation pays taxes on its income separate from the owners and shareholders. A corporation is taxed on all profits that cannot be deducted as business expenses. Expenses that can be deducted include start-up costs, operating expenses, and product and advertising outlays, salaries and bonuses paid to employees and the costs of medical and retirement plans for employees. Taxable profits usually consist of money kept in the company to cover expenses or expansion ("retained earnings") and profits distributed to shareholders as dividends. Corporations are required to estimate their taxes and make quarterly payments in April, June, September, and January.

Because dividends paid to shareholders cannot be deducted as business expenses, they are taxed at the corporate level. They are also taxed as part of the shareholders’ personal income, so in essence they are taxed twice. For example, a C-corporation needs to pay corporate taxes on its business income and the shareholders of the C-corporation will also pay personal income taxes when they receive the profits or dividends from the corporation.

A limited liability company (LLC) offers the benefits of limited liability and pass-through taxation. In an LLC, the members can divide income and tax liability that they wish, whereas in an S-corporation, this is dependent on the percentage of the business owned. LLCs are also not subject to many of the restrictions that S-corporations are subject to. If operational ease and flexibility are important to you, an LLC is a good choice. If you are looking to save on employment tax and your situation warrants it, an S-corporation could work for you.

The main benefit of an S-corporation is pass-through taxation, where profits are only taxed as part of each shareholder’s personal income, rather than both at the corporate and the shareholder level. Business losses from an S-corporation can be used to offset other income on a tax return, and you are not subject to self-employment tax. If you sell the S-corporation, you will probably be taxed less on the gain than if it were a regular corporation. However, there are many limitations placed on S corporations. For instance, profits and losses must be distributed to shareholders in proportion to their interest in the business, and S-corporations can only issue one class of stock. The maximum number of shareholders is 100, and they must be the U.S. citizens or residents. Generally, shareholders in an S-corporation must also be individuals. Corporate shareholders are usually not permitted, though 501(c)(3) corporations (nonprofit corporations) can be shareholders of an S-corporation.

An S-corporation is first set up as a regular corporation following the same steps as other corporations. The difference is that you need to elect to be taxed as an S-corporation. This is done by submitting IRS Form 2553, which must be signed by all the shareholders.

The above is intended as a general introduction and should not be construed as legal advice or legal opinion for your particular case. Please contact the Law Offices of Yu & Associates with any specific questions. Tel: (301) 838-8986, Email: syu@yulegal.com, Address: 110 N Washington Street, Suite 328E, Rockville, MD 20850.