Should I Choose an S or C Corporation for My Small Business?
It’s a critical decision for New Jersey startup ownersBy Doug Mentes, Esq. | Last updated on January 11, 2023
Use these links to jump to different sections:IRS Form 2553 – Election by a Small Business Corporation. The entity form is called an S corporation because the law allowing it is found under subchapter S, Chapter 1 of the IRS code. Regardless of the choice, the first step for New Jersey business startups is to register their corporation with the state—by filing Articles of Incorporation. Part of that process will be designating which form of business entity the owners choose. New Jersey business owners electing to register as an S Corp must apply and obtain approval for that status from the state of New Jersey, separate from filing the election with the IRS.
Why Choose an S Corporation?Small businesses chose to form as a S Corp because of tax savings. Like sole proprietors and partnerships, S Corporations are flow-through entities, meaning the income is not reported at the corporate level, but flows through to the owners who report their business income as personal income. Compare that to Income earned by a C Corporations, which does not flow through and is taxed at the corporate level. If the C Corp then distributes that income as dividends to the owners, or shareholders, those dividends are taxed as personal income to the owners. This is referred to as double taxation; avoiding it is the reason to choose the S Corporation structure. However, this does not eliminate the possibility of paying state corporate income tax to New Jersey for some S corporations. A quick review of corporate and individual income tax rates will demonstrate the clear tax benefit for small business S corporations.
Why Choose a C Corporation?With election of a S corporation comes several requirements on those businesses, including:
- No more than 100 shareholders allowed
- Can only issue one class of stock share
- All shareholders must be U.S. residents
- Cannot be owned by a separate entity, such as a C Corp, other S Corporation, LLC, partnerships and many trusts
- Fringe benefits to employees are often not tax deductible
Similarities?Both forms still offer limited liability protection, meaning owners and shareholders are personally protected from liabilities of the business. There is also the entity form of Limited Liability Companies (LLCs) to consider. LLCs are not corporations and are a more recent creation meant to offer the advantage of limited liability to those formed as sole proprietors and partnerships. In 2018 and going forward, tax reform will have an impact on both S and C Corporations—both business forms likely seeing their tax burdens decrease—although the tax cuts given to S corporations sunset, while the tax cuts to C Corporations remain permanent. Determining which type of corporation to form is an important decision for the business. Small businesses should consult with an experienced New Jersey business attorney to ensure their business is set up for the greatest possible success. For more information on this area of law, see our overviews of S corporations, closely held business, business organizations and business and corporate law.
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