There’s no question that entrepreneurs and small businesses are the life blood of this great nation. For those just starting out or who are only now considering incorporating an existing business, your choice of entity is critical. While I’m personally partial to limited liability companies for most small businesses, many individuals, for a myriad of reasons, still want to conduct business as a traditional corporation. While other forms of corporations exist, the two most common for-profit types are S-corporations and C-corporations. If you’re undertaking to incorporate, you need to understand the difference between them and how they can affect you, especially your bottom line.

In order to create a corporation, one initiates the process by filing article of incorporation with the Department of State. Aside from indicating your intention to create a new entity, articles of incorporation do not state what type of corporation you are filing. By default, corporations are considered C-corporations under subchapter “C" of the tax code upon formation. S status is secured only when the entity files for same with the Internal Revenue Service (IRS).

On many levels, the choice between C or S status is irrelevant. Both forms provide owners with limited liability. This is generally the paramount reason individuals decide to incorporate in the first place; to avoid personally liability resulting from the ordinary, everyday operation of your company. The shield which results from incorporating results from the fact that corporations are considered entities separate and apart from their owners and directors. Corporations, nonetheless, are still owned by their shareholders and controlled by their boards of directors.

The real difference between C-corporations and those which choose an S election comes down to tax treatment under the Internal Revenue Code. Traditional C-corporations face two levels of taxations. Not only will the entity pays taxes on the net income it generates, but its shareholders will pay a secondary layer of taxes on the distributions they receive from the entity. S-corporations, however, are not subject to this double layer of taxation. Rather, they are instead subject only to a single level of taxation at the shareholder level, and ate referred to as “pass-through" entities. In this sense, corporations which choose an S election are treated instead much like LLCs or partnerships.

In order to be an S-corporation, your entity must be limited to no more than 100 shareholders, all of which must be U.S. citizens or resident aliens. Shareholder status is not limited to natural persons, but can also be enjoyed by other corporations (remember, corporations are separate entities in the eyes of the law).

In order to choose S status from the beginning, the corporation must file an S election with the IRS within 75 days of formation. If you elect S status from the beginning (or during the election period), your business will never be treated as a C-corporation. If you miss that window and are considered for taxation purposes as a C corporation, all hope is not necessarily lost. C-corporations can convert to S status, but it may not be that simple. Because of its complicated accounting rules, many C-corporations find it difficult to convert to S status, at least without the risk of nonetheless facing that double layer of corporate taxation because of a built-in gain tax that was instituted to take effect upon conversion from a C to S. Nonetheless, the law does provide a mechanism for converting from a C to an S corporation, just as it provides a mechanism for converting from an S to a C if desired.

When one weights all of the costs and benefits associated with a C-corp versus an S-corp, it ends up making very little sense for most small business owners to stick with C-corp status to run their business. Aside from the fact that small businesses fiscally can’t afford the hit of paying the two levels of taxation that accompany C-corp status, conducting business as an S-corp allows business owners to personally claim losses on their taxes – a feature simply not offered by C-corporations. At the end of the day, corporations have their time and place. If you’re considering one over an LLC, you need to at least make sure you elect wisely when forming one so as to get the most out of your chosen entity. Last but not least, rules and laws change regularly, so always consult with counsel when choosing an entity form. While this article gives one a sense of the differences between S-corps and C-corps, there are multiple other differences that I’ve not touched on which could affect your choice of entity.