A corporation is a legal person with rights and obligations. It may sue or be sued. It must file income tax returns. It can own real estate and personal property and contract its own debts. A corporation is a legal entity separate and distinct from its owners. It is considered a limited liability entity, as none of the owners (i.e., shareholders) are typically liable for the corporation’s debts by virtue of being a shareholder. A “C” corporation is a corporation that has not made an election to be an “S” corporation.

No. An LLC is not a type of corporation at all. Please note that “LLC” does not stand for “Limited Liability Corporation.” Rather, the acronym “LLC” stands for “Limited Liability Company.” The document (articles) filed with the Secretary of State to form a corporation and an LLC are not the same.

Corporations follow the principle of centralized management. In the simplest and most common corporate structure, shareholders elect the board of directors, who in turn appoint officers over whom the shareholders have no direct control. The board of directors is responsible for managing the business and affairs of the corporation with day-to-day control resting with the officers. The shareholders have no right to participate in the day-to-day management of the business.

All corporations formed by default are “C” corporations. A C corporation is a corporation that has not made an election to be an “S” corporation. The term C corporation is specifically used because the entity is taxed under subsection C of the IRS code. C corporations are taxed at two levels (“double taxation”). This means that the corporation itself pays its own tax when it makes money (the first tax). The owners or shareholders are then taxed again when they are paid a salary or dividend by the corporation (the second tax). Despite double taxation, C corporations offer many planning and benefit opportunities. For example, a C corporation can be used to accumulate assets or wealth at corporate tax rates, which are lower than the individual tax rates.

An “S” corporation is a corporation that has made an election with the IRS to be treated for tax purposes as a “pass-through entity.” This means that corporate profits and losses are passed through to the shareholders (owners) who report them on their own personal tax returns and pay the tax at the individual level. The corporation pays no federal income tax at the corporate level. The “S” in S corporation refers to the subsection of the IRS code under which the corporation is taxed.

No. Not all corporations are able to take advantage of S corporation status. A corporation is only eligible for an S-corporation election if the following ownership requirements are satisfied:

1. The corporation must have no more than 100 shareholders (a husband and wife qualify as one shareholder);
2. All shareholders must be citizens or residents of the United States. Non-resident aliens may not hold shares.
3. All shareholders must be individuals and not other corporations or LLCs (estates, some exempt organizations and certain trusts qualify as shareholders);
4. There can only be one class of stock in the company (differences in voting rights are permitted);
5. The company making the election cannot be a bank or thrift institution, an insurance company, or a domestic international sales corporation;
6. Each shareholder must consent to the S corporation tax status; and
7. No more than 25% the company’s gross corporate income may be derived from passive investment activities.

No, the decision to elect to be an S corporation is not permanent. If it later becomes apparent that there are tax advantages to operating as a C corporation, you may easily drop your S corporation status after a certain amount of time.

C corporations offer numerous advantages. Among them are:

• Limited liability: The primary advantage of a corporation is limiting the liability of its owners. Unless (1) a member personally guarantees a debt; (2) the LLC fails to have a separate bank account and personal funds are commingled with LLC funds; (3) the LLC is undercapitalized; or (4) the LLC fails to pay state taxes or otherwise violates state law, the owners are not liable for the debts and obligations of the corporation. In a partnership or sole proprietorship, creditors may seize personal assets of the participants to pay debts of the business.
• 15% tax on corporate profits/income shifting: The ability to split income between a corporation and its shareholders in a manner that lowers overall taxes is referred to as Income Shifting. This practice is by far one of the greatest benefits of incorporating a business. Profitable small businesses with shareholders in higher tax brackets stand to benefit the most from the practice of income shifting. However, paying out ALL profits may not be viable for a corporation who plans to retain earnings to expand its product line or increase its advertising budget next year. Fortunately, profits retained within a corporation are taxed at the initial tax rate of only 15%. It is this ability to retain earnings within the business, without imputing tax liability to shareholders that provides an invaluable tax advantage to growing corporations that is not available to S corporations and unincorporated business entities. It is important to note, however, that certain “personal service corporations” are subject to a flat tax of 35% regardless of their income.
• Deductible fringe benefits: One of the benefits of a corporation is having it provide lucrative employee benefits that are deductible by the corporation and tax free to the employees. Medical, life insurance, education, childcare, and retirement plans are just a few of the types of benefits available.
• Ability to deduct business operating losses: Corporations have very few restrictions on the amount of capital or operating losses that a corporation may carry back or forward to subsequent tax years. Unincorporated entities, however, face more stringent rules regarding corporate losses. For example, an individual owning a sole proprietorship cannot claim a capital loss greater than $3,000 unless he or she has offsetting capital gains.
• Lower chance of IRS audit: IRS Form 1040, Schedule C (Profit or Loss from a Business), which is used by sole proprietors to report the businesses income and expenses, is the target of many IRS audits. The audit rates of similar businesses that have incorporated are much lower.

The disadvantages of a C corporation include:

• Double taxation: The primary disadvantage to a C corporation is double taxation. Profits of a corporation are taxed twice when the profits are distributed to shareholders as dividends. They are taxed first as income to the corporation, then as income to the shareholder. All reasonable business expenses such as salaries are deductions against corporate income and can minimize the double tax. This double tax, however, can easily be eliminated by making an S corporation election.
• Shareholders of C corporations cannot deduct operating losses: Members who are active participants in the business of an LLC are able to deduct operating losses of the S Corp against their regular income to the extent permitted by law. Shareholders of an S corporation are also able to deduct operating losses, but not shareholders of a C corporation.
• More corporate formalities: Corporations must hold regular meetings of the board of directors and shareholders and keep written corporate minutes. Members and managers of an LLC need not hold regular meetings.

S corporations offer numerous advantages. Among them are:

• Limited liability: The primary advantage of a corporation is limiting the liability of its owners. Unless (1) a member personally guarantees a debt; (2) the corporation fails to have a separate bank account and personal funds are commingled with corporation funds; (3) the corporation is undercapitalized; or (4) the corporation fails to pay state taxes or otherwise violates state law, the owners are not liable for the debts and obligations of the corporation. In a partnership or sole proprietorship, creditors may seize personal assets of the participants to pay debts of the business.
• No double taxation: One of the main advantages of S corporation status is that it avoids the double taxation that occurs with a regular C corporation. In a C corporation, the corporation pays income tax on its profits and, if those profits are distributed to shareholders, the shareholders pay income tax on the distribution.
• Self-employment tax savings: By electing S corporation status, only the earnings actually paid out to you as salary are subject to payroll taxes; money left in the business is not subject to payroll taxes or self-employment tax. All income passes through, but its tax status depends on whether it is classified as salary or ordinary income. Here’s an example: If you had net income of $60,000 and paid yourself $40,000 in salary, leaving $20,000 in the business, as a sole proprietor or LLC member, you would pay self-employment tax on the full $60,000 ($60,000 x 15.3% = $9,180). But as an S corporation, you would only owe self-employment tax on the $40,000 in salary ($40,000 x 15.3% = $6,120), resulting in a savings of $3,060. This is a distinct disadvantage if you want to let earnings accumulate in the corporation, free of self-employment taxes, which is not possible in an LLC at this time. However, LLCs do have the option of electing to be taxed like an S corporation.
• Loss deductions: The availability of losses. Shareholders of an S corporation generally may deduct their share of the corporation’s net operating loss on their individual tax returns in the year the loss occurs. Losses of a C corporation, however, may offset only the corporation’s earnings. This pass-through of an S corporation’s losses to its shareholders makes the S corporation form particularly suitable for start-up businesses that are expected to generate losses during their initial stages. The shareholders of an S Corporation are limited in the amount they can deduct as a result of business losses, in rough terms to the amount of their “basis” or investment in the corporation. Even though losses pass through to shareholders in an S corporation, those losses aren’t deductible by shareholders who don’t materially participate in the business.
• Lower chance of IRS audit: IRS Form 1040, Schedule C (Profit or Loss from a Business), which is used by sole proprietors to report the businesses income and expenses, is the target of many IRS audits, however. The audit rates of similar businesses that have incorporated are much lower.

The disadvantages of an S corporation include:

• Ownership restrictions: S corporations cannot have more than 100 stockholders, and each stockholder must be an individual who is a resident or citizen of the United States. If, for any reason, shares are somehow sold or transferred (even by will, divorce, or other means) to a shareholder who is a foreign national, the corporation will lose its S corporation status and be treated as a C corporation. Also, it is difficult to place shares of an S corporation into a living trust. None of these restrictions or difficulties apply to an LLC.
• Income recognition: Passing income through to shareholders can be a disadvantage in some instances. If the business is profitable, shareholders will be required to pay income tax on their share of the profits, even if that money is not distributed to them. In a C corporation, profits can be used to expand the business and shareholders are not required to pay taxes until distributions are made.
• Fringe benefits: Reasonable salaries paid to employees are deductible business expenses for S corporations as well as for C corporations. However, in an S corporation, fringe benefits may snot be deductible as they would be in a C corporation.

Professional corporations are corporations organized for the purpose of providing professional services. Typically, professions that require a license, such as doctors, lawyers, chiropractors, accountants, architects, or engineers are required to form professional corporations. Typically, professional corporations must be organized for the sole purpose of rendering professional services of the licensed practitioners.

Professional corporations can be either “C” or “S” corporations.

In California, the following licensed professionals are NOT permitted to form regular “for profit” corporations or LLC’s, and must instead form “professional corporations”:

• Accountants
• Acupuncturists
• Architects*
• Attorneys
• Chiropractors
• Clinical Social Workers (Licensed)
• Dentists
• Doctors
• Marriage and Family Therapists
• Naturopathic Doctors
• Nurses
• Optometrists
• Osteopaths
• Pest control
• Pharmacists
• Physical Therapists
• Physician Assistants
• Podiatrists
• Psychologists
• Shorthand Reporters
• Speech-Language Pathologists and Audiologists
• Veterinarians*

*Note: Architects and veterinarians have the option to incorporate as either regular business corporations or as professional corporations.

Professional corporations offer numerous advantages. Among them are:

• Limited liability: The primary advantage of a corporation is limiting the liability of its owners. Unless they personally guarantee them, the members are not liable for the debts and obligations of the corporation. In a partnership or sole proprietorship, creditors may seize personal assets of the participants to pay debts of the business. Professional corporations also offer limited liability for business claims and for malpractice claims against other professionals in the practice (though professionals do not have limited liability for their own malpractice).
• Self-employment tax savings: By electing S-corporation status, only the earnings actually paid out to you as salary are subject to payroll taxes; money left in the business is not subject to payroll taxes or self-employment tax. All income passes through, but its tax status depends on whether it is classified as salary or ordinary income. Here’s an example: If you had net income of $60,000 and paid yourself $40,000 in salary, leaving $20,000 in the business, as a sole proprietor, you would pay self-employment tax on the full $60,000 ($60,000 x 15.3% = $9,180). But as a corporation, you would only owe self-employment tax on the $40,000 in salary ($40,000 x 15.3% = $6,120), resulting in a savings of $3,060. Please note that a stockholder-employee must pay himself or herself a reasonable salary, or else the IRS could re-characterize some or all of the corporate profits as salary.
• Loss deductions: By electing S-corporation status, a professional has the ability to offset any losses (which usually occur in the early years of a new business) against income from other income sources. For example, a physician starting a new practice could offset a portion of incurred losses against the salary they receive as a part-time hospital physician. The shareholders of an S-Corporation are limited in the amount they can deduct as a result of business losses, in rough terms to the amount of their “basis” or investment in the corporation.
• Fringe benefits: If the professional corporation opts to be treated as a C-corporation, it has the benefit of being able to provide lucrative employee benefits that are deductible by the corporation and tax free to the employees. Medical insurance, life insurance, education, childcare, and retirement plans are just a few of the types of benefits available.