Is a C-Corporation or a S-Corporation Right for You?

Nash Law Firm, PLLC
By:  David C. Nyberg
nyberg@nash-law.com

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The previous article in this series discussed two entities that do not provide limited liability for owners.  This article will discuss an entity type that does provide limited liability: corporations, and the two different types of corporations a business venture may operate under; C corporation and S corporation.

Corporations

A corporation is a legal entity created in compliance with Minnesota law that is separate and distinct from its owners.  A corporation is owned by its shareholders, who elect the directors, who then run the operation of the corporation and appoint or hire officers to run the daily operations of the corporation.  Shareholders of the corporation receive limited liability protection from the corporation’s creditors. 

The primary disadvantages of a corporation are the onerous formalities and recordkeeping requirements.  Among other things, state law requires corporations to hold annual meetings, adopt bylaws, elect directors, maintain separate books and records, and maintain capitalization requirements.

C Corporation

A C-corporation is the most common type of corporation.  If all corporate formalities are followed, the C-corporation is the best and most widely accepted entity for personal liability protection.  A C- corporation is also the best entity to attract outside investment.  This is because C-corporations have a very flexible capital structure.  The C-corporation may have different classes of stock, issue options to employees and consultants, and issue a wide range of other financial instruments.

The primary disadvantage of a C-corporation is that it does not receive flow-through tax treatment which results in “double taxation.”  Double taxation means that the corporation itself is taxed on profits and then each shareholder is taxed on any dividend distributed to them.  This can be an advantage when seeking outside investment because many investors will not invest in entities that have flow-through tax treatment.  

A C-corporation is ideal for ventures seeking strong personal liability protection as well as substantial outside financing.  C-corporations may also be the “default” entity of choice for those ventures that don’t meet the requirements of the S-corporation. 

S Corporation

An S-corporation is formed in the same manner as a C-corporation except that an election is made to be taxed as an S corporation.  This election results in the S corporation being treated as a flow-through entity for tax purposes and thus it is not subject to double taxation.  The S corporation, similar to a C corporation, is a very effective entity for personal liability protection.  Additionally, it is very easy to convert an S corporation to a C corporation if the need arises.

The biggest drawback to an S-corporation is the limitation on type and number of shareholders.  S-corporations are limited to 100 shareholders who must be U.S. citizens or residents, estates, or certain trusts.  Additionally, S-corporations may only have one class of stock which is unattractive to many investors.

S-corporations are ideal for ventures seeking strong personal liability protection and flow-through tax treatment.  The ease of converting to a C-corporation also makes the S-corporation viable for companies who will seek large amounts of outside financing in the future, but desire flow-through tax treatment in the meantime.

Is a limited partnership or a limited liability company right for you?

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NOTICE The foregoing is not intended to constitute legal advice for any specific circumstance, but is intended to reflect broadly applicable principles, under Minnesota law, relevant to a typical situation. Each set of facts and each contract is, or can be unique; the unique facts and specific language of the contract may require a different legal analysis and may result in a different outcome. Before proceeding in reliance upon this or any other general description of law, consult with an attorney competent in the field of practice relevant to your situation. Copyright 2011 Nash Law Firm