S corporation vs. C corporation: The differences
Unity 1 Glossary
ARTICLES OF ASSOCIATION: The term articles of association of a company, or articles of incorporation, of an American or Canadian Company, are often simply referred to as articles (and are often capitalized as an abbreviation for the full term). The Articles are a requirement for the establishment of a company under the law of India, the United Kingdom and many other countries. Together with the memorandum of association, they are the constitution of a company. The equivalent term for LLC is Articles of Organization.
The Articles can cover a medley of topics:
§ the issuing of shares (also called stock), different voting rights attached to different classes of shares
§ valuation of intellectual rights, say, the valuations of the IPR of one partner and, in a similar way as how we value real estate of another partner
§ the appointments of directors - which shows whether a shareholder dominates or shares equality with all contributors
§ directors meetings - the quorum and percentage of vote
§ management decisions - whether the board manages or a founder
§ transferability of shares - assignment rights of the founders or other members of the company do
§ special voting rights of a Chairman, and his/her mode of election
§ the dividend policy - a percentage of profits to be declared when there is profit or otherwise
§ winding up - the conditions, notice to members
§ confidentiality of know-how and the founders' agreement and penalties for disclosure
§ first right of refusal - purchase rights and counter-bid by a founder.
A Company is essentially run by the shareholders, but for convenience, and day-to-day working, by the elected Directors. Usually, the shareholders elect a Board of Directors (BOD) at the Annual General Meeting (AGM).
BOARD OF DIRECTORS: A body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors. It is often simply referred to as "the board". In some European Union and Asian countries, there are two separate boards, an executive board, also called corporate executive team, for day-to-day business and a supervisory board, also called board of directors (elected by the shareholders) for supervising the executive board. A board's activities are determined by the powers, duties, and responsibilities delegated to it or conferred on it by an authority outside itself. These matters are typically detailed in the organization's bylaws. The bylaws commonly also specify the number of members of the board, how they are to be chosen, and when they are to meet. In an organization with voting members, e.g., a professional society, the board acts on behalf of, and is subordinate to, the organization's full assembly, which usually chooses the members of the board. In a stock corporation, the board is elected by the stockholders and is the highest authority in the management of the corporation. In a non-stock corporation with no general voting membership, e.g., a university, the board is the supreme governing body of the institution; its members are sometimes chosen by the board itself. Typical duties of boards of directors include:
§ governing the organization by establishing broad policies and objectives;
§ selecting, appointing, supporting and reviewing the performance of the chief executive;
§ ensuring the availability of adequate financial resources;
§ approving annual budgets;
§ accounting to the stakeholders for the organization's performance;
§ setting the salaries and compensation of company management.
The legal responsibilities of boards and board members vary with the nature of the organization, and with the jurisdiction within which it operates. For public corporations, these responsibilities are typically much more rigorous and complex than for those of other types. Typically the board chooses one of its members to be the chairman, who holds whatever title is specified in the bylaws.
BUSINESS TRUST: A Massachusetts business trust (MBT) is a legal trust set up for the purposes of business, but not necessarily one that is operated in the commonwealth of Massachusetts. They may also be referred to as an unincorporated business organization or UBO. Business trusts may be established under the laws of other U.S. states.
Many businesses are formed as MBTs to mitigate taxation; mutual funds in the U.S. are often structured as MBTs, though sometimes they are organized as Maryland corporations (or other states such as Minnesota). More recently, a Delaware statutory trust or DST has become a popular form of organization, and many new funds have been organizing as DSTs and exiting funds converting to DSTs. Since mutual funds are investment companies and not operating companies, many traditional corporation rules and requirements don't fit them well.
COMPANY FORMATION: In the U.K., the process of incorporation is generally called company formation. The United Kingdom is one of the quickest locations to incorporate, with a fully electronic process and a very fast turnaround by the national registrar of companies, the Companies House. The current Companies House record is five minutes to vet and issue a certificate of incorporation for an electronic application.
CORPORATION: This state chartered organization acts as a separate legal entity and is the most structured business entity. Business activities are restricted to those listed in the corporate charter. Corporations may elect to file as a C-Corporation or S-Corporation. The differences are defined by the tax filing status as determined by the chapters in the Internal Revenue Code.
C CORPORATION:C corporations are separately taxable entities. They file a corporate tax return (Form 1120) and pay taxes at the corporate level. They also face the possibility of double taxation if corporate income is distributed to business owners as dividends, which are considered personal income. Tax on corporate income is paid first at the corporate level and again at the individual level on dividends.
C CORPORATION VS S CORPORATION: C corporation is the standard corporation, while the S corporation has elected a special tax status with the IRS. It gets its name because it is defined in Subchapter S of the Internal Revenue Code. To elect S corporation status when forming a corporation, Form 2553 must be filed with the IRS and all S corporation guidelines met. C corporations and S corporations share many qualities:
· Limited liability protection. Both offer limited liability protection, so shareholders (owners) are typically not personally responsible for business debts and liabilities.
· Separate entities. Both the S corporation and C corporation are separate legal entities created by a state filing.
· Filing documents. Formation documents must be filed with the state. These documents, typically called the Articles of Incorporation or Certificate of Incorporation, are the same for both C and S corporations.
· Structure. Both have shareholders, directors and officers. Shareholders are the owners of the company and elect the board of directors, who in turn oversee and direct corporation affairs and decision-making but are not responsible for day-to-day operations. The directors elect the officers to manage daily business affairs.
· Corporate formalities. Both are required to follow the same internal and external corporate formalities and obligations, such as adopting bylaws, issuing stock, holding shareholder and director meetings, filing annual reports, and paying annual fees.
S corporation vs. C corporation: The differences
Despite their many similarities, S corporations and C corporations also have distinct differences.
· Taxation. Taxation is often considered the most significant difference for small business owners when evaluating S corporations vs. C corporations.
CONTRACT RISK: It is probability of loss arising from the buyer’s reneging on the contract, as opposed to the buyer’s inability to pay. It is probability of loss arising from failure in contract performance. Vendors have the highest risk in fixed price contracts and least in the cost type contracts.
CORPORATE OWNERSHIP:C corporations have no restrictions on ownership, but S corporations do. S corps are restricted to no more than 100 shareholders, and shareholders must be US citizens/residents. S corporations cannot be owned by C corporations, other S corporations, LLCs, partnerships or many trusts. Also, S corporations can only have one class of shares.
GENERAL PARTNERSHIP: Allows two or more people to share profits and liabilities. A general partnership is similar to a sole proprietorship, except that two or more parties are involved. In a business partnership, the parties that join forces could be individuals, corporations, trusts, other partnerships, or a combination of all of the above.
· Advantages:Advantages are that it is easy to establish, can draw upon the financial and managerial strength of all the partners, and the profits are not directly taxed.
· Disadvantages:Some disadvantages are unlimited personal liability of the partners for the firm's debts and liabilities, termination of the business with the death of a partner (in the absence of advanced planning for business continuation) and the fact that any one of the partners can commit the firm to obligations. It is important to understand that a general partnership does not protect its partners from personal liability with respect to claims against the partnership. The partnership is formed by an agreement entered into by each partner. This agreement may be informal, but it is advisable to have a written agreement drawn up between all parties.
LEGAL BENEFIT OF INCORPORATION: Protection of personal assets. One of the most important legal benefits is the safeguarding of personal assets against the claims of creditors and lawsuits. Sole proprietors and general partners in a partnership are personally and jointly responsible for all the liabilities of a business such as loans, accounts payable, and legal judgments. In a corporation, however, stockholders, directors and officers typically are not liable for the company's debts and obligations. They are limited in liability to the amount they have invested in the corporation. For example, if a shareholder purchased $100 in stock, no more than $100 can be lost. Corporations and limited liability companies (LLCs) may hold assets such as real estate, cars or boats. If a shareholder of a corporation is personally involved in a lawsuit or bankruptcy, these assets may be protected. A creditor of a shareholder of a corporation or LLC cannot seize the assets of the company. However, the creditor can seize ownership shares in the corporation, as they are considered a personal asset.
§ Transferable ownership. Ownership in a corporation or LLC is easily transferable to others, either in whole or in part. Some state laws are particularly corporate-friendly. For example, the transfer of ownership in a corporation incorporated in Delaware is not required to be filed or recorded.
§ Retirement funds. Retirement funds and qualified retirements plans, such as a 401(k), may be established more easily.
§ Taxation. In the United States, corporations are taxed at a lower rate than individuals are. Also, they can own shares in other corporations and receive corporate dividends 80% tax-free. There are no limits on the amount of losses a corporation may carry forward to subsequent tax years. A sole proprietorship, on the other hand, cannot claim a capital loss greater than $3,000 unless the owner has offsetting capital gains.
§ Raising funds through sale of stock. A corporation can easily raise capital from investors through the sale of stock.
§ Durability. A corporation is capable of continuing indefinitely. Its existence is not affected by the death of shareholders, directors, or officers of the corporation.
§ Credit rating. Regardless of an owner's personal credit scores, a corporation can acquire its own credit rating, and build a separate credit history by applying for and using corporate credit.
LEGAL TYPES: The three primary types of legal firm organizations are: (1) proprietorship, (2) partnership, and (3) corporation. One primary difference between these three legal types are number of owners -- proprietorship has one, partnership has two or more (but usually a small number), and corporation can have anywhere from one or to millions. A second difference is the liability of the owners -- proprietorship and partnership owners have unlimited liability and corporation owners have limited liability. Three newer firm types include (1) limited partnership, (2) S corporation, and (3) limited liability company. Each of these three are hybrids, with characteristics of proprietorship, partnership, corporation.
LEVERAGE: In finance, leverage (sometimes referred to as gearing in the United Kingdom, or solvency in Australia) is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. The examples could be:
§ A public corporation may leverage its equity by borrowing money. The more it borrows the less equity capital it needs, so any profits or losses are shared among a smaller base and are proportionately larger as a result.
§ A business entity can leverage its revenue by buying fixed assets. This will increase the proportion of fixed, as opposed to variable, costs, meaning that a change in revenue will result in a larger change in operating income.
§ Hedge funds often leverage their assets by using derivatives. A fund might get any gains or losses on $20 million worth of crude oil by posting $1 million of cash as margin.
LIMITED LIABILITY COMPANY: A separate legal entity, the LLC is a hybrid between a partnership and a corporation, combining the limited liability advantage of a corporation with the tax status of a sole proprietor or partnership. Owners of the LLC are called members.
· Advantages:Similar to the partnership entities, the LLC is governed by an operating agreement, or in the absence of one, by the Connecticut Limited Liability Company Act. The LLC may be formed by one or more members. As a separate legal entity, LLC's may own property, sue, and be sued in LLC's name. Managers of an LLC as elected by the members may be in the form of a person or other entity. Unless otherwise specified by the Articles of Organization, LLC's enjoy perpetual continuity similarly as in a corporation.
· Disadvantages:Since a LLC is a legal entity, the formation of a LLC requires more legal documentation than in a general partnership or sole proprietorship
LIMITED PARTNERSHIP: separate legal entity, this type of business includes a general partner and one or more limited partners who invest capital into the partnership, but do not take part in the daily operation or management of the business. The limited partners limit their amount of liability to the amount of capital invested in the partnership. The general partner shoulders the personal liability for the debts and obligations of the partnership. Business operations are governed, unless otherwise specified in a written agreement, by majority vote of voting partners. LPs are legal entities formed with the Connecticut Secretary of the State.
· Advantages:LPs provide a legal structure to the establishment of the business. From a capital investment standpoint, limited partners are shielded from the liability in that their liability is dependent upon the amount of capital invested. In addition, dividends distributed to all partners are reported on the partners' personal income tax return. There are no restrictions as to the amount of dividends that the general partners may receive from the business. General partners of a LP may be in the form of another person or company. As a separate legal entity, LP's may own property, sue, and be sued in LP's name.
· Disadvantages:In a LP there must be at least one general partner and it is the general partner(s) that incur unlimited liability. As in any partnership, a LP must draft a partnership agreement, which governs how the business is operated. In a LP the partnership agreement must state a date of termination. Since a LP is a legal entity, the formation of a LP requires more legal documentation than in a general partnership.
LIMITED LIABILITY PARTNERSHIP: A separate legal entity, an LLP provides liability protection for all general partners as well as management rights in the business. Most commonly used in professional practices, an LLP offers, in most cases, the same limited liability enjoyed by a corporation, but at the same time it is a flow-through entity for federal and Connecticut tax purposes, just like a partnership. LLP’s are legal entities formed with the Connecticut Secretary of the State.
· Advantages:LLP’s provide a legal structure to the establishment of the business. From a capital investment standpoint, limited partners are shielded from the liability in that their liability is dependent upon the amount of capital invested. In addition, dividends distributed to all partners are reported on the partners’ personal income tax return. As in any partnership, a LLP must draft a partnership agreement, which governs how the business is operated. There is no requirement to set a termination date of the partnership agreement. As a separate legal entity, LLP’s may own property, sue, and be sued in LLP’s name.
· Disadvantages:Since a LLP is a legal entity, the formation of a LLP requires more legal documentation than in a general partnership. If a LLP drops or loses a partner, the business is automatically deemed dissolved.
MEMORANDUM OF ASSOCIATION: The memorandum of association of a company, often simply called the memorandum (and then often capitalized as an abbreviation for the official name, which is a proper noun and usually includes other words), is the document that governs the relationship between the company and the outside. It is one of the documents required to incorporate a company in the United Kingdom, Ireland, India, Bangladesh, Pakistan and Sri Lanka, and is also used in many of the common law jurisdictions of the Commonwealth.
NONPROFIT CORPORATION: A nonprofit corporation is a legal entity that is formed as a non stock corporation with the intent to not realize a profit, but is established for a religious, charitable, educational, literary or scientific purpose. Qualifying nonprofit corporations will be granted tax-exempt status by both federal and state authorities.
OWNERSHIP AND CONTROL: Ownership means that you have legal "title" to a resource, good, or commodity. Control means that you have the ability to determine how a resource, good, or commodity is used. While it would seem as though these two always go together, such is not the case. People generally have ownership and control over their labor and personal property (clothing, furniture, canned goods, etc.). But in some circumstances ownership is absent of control and control exists without ownership.
OWNERSHIP LIABILITY: The extent to which the owners of a business are liable for the debts of the company. The two basic liability alternatives are unlimited liability, which has no restrictions on ownership liability, and limited liability, which does have restrictions. Ownership liability is one characteristic separating legal business organizations. Proprietorships and partnerships have unlimited liability. Corporations have limited liability.
PASS-THROUGH TAXATION: Method in which a firm’s owners pay income tax on the firm’s income and not the firm.
PERSONAL INCOME TAXES:With both types of corporations, personal income tax is due both on any salary drawn from the corporation and from any dividends received from the corporation.
PROFESSIONAL CORPORATIONS: are those corporate entities for which many corporation statutes make special provision, regulating the use of the corporate form by licensed professionals such as attorneys, architects, engineers, public accountants and physicians. Legal regulations applying to professional corporations typically differ in important ways from those applying to other corporations. Professional corporations, which may have a single director or multiple directors, do not usually afford that person or persons the same degree of limitation of liability as ordinary business corporations (cf. LLP). Such corporations must identify themselves as professional corporations by including "PC" or "P.C." after the firm's name. Professional corporations often exist as part of a larger, more complicated, legal entity; for example, a law firm or medical practice might be organized as a partnership of several or many professional corporations
S CORPORATIONS: S corporations are pass-through tax entities. They file an informational federal return (Form 1120S), but no income tax is paid at the corporate level. The profits/losses of the business are instead “passed-through” the business and reported on the owners’ personal tax returns. Any tax due is paid at the individual level by the owners.
SOLE PROPRIETORSHIP: A sole proprietorship by definition means "one owner". The owner assumes all responsibilities for the business, including assets and liabilities. Business income is taxed as personal income. Most small businesses operate as sole proprietorships, this being the simplest form of organization and allowing the single owner to have sole control and responsibility. The business may use a trade name, but the business does not have a separate legal existence apart from its owner under state law. Trade names (often referred to as fictitious names, DBA or doing business as) must register with the town or city clerk in the town or city where the business is located.
· Advantages:Some advantages of the sole proprietorship are less paperwork, minimal legal restrictions, owner retention of all profits, and ease in discontinuing the business. In most cases, a sole proprietorship is not required to obtain an Employer Identification Number (EIN) from the Internal Revenue Services unless it has employees. There is no need to file a separate income tax return for the proprietorship because the activity is reported on the owner's federal and individual income tax returns. Since a self-employed person is not considered an employee, there is no provision to withhold payroll taxes to cover federal, state, and Social Security tax obligations. If you are a self- employed sole proprietor, you must make quarterly estimated payments to provide for these tax liabilities.
· Disadvantages:Disadvantages include unlimited personal liability for all debts and liabilities of the business, limited ability to raise capital, and termination of the business upon the owner's death. You should note that a small business owner might very well select the sole proprietorship to begin, and later, he or she may decide to form a different business type such as a limited liability company or corporation.
TAX RETURN: Tax returns in the United States are reports filed with the Internal Revenue Service (IRS) or with the state or local tax collection agency (California Franchise Tax Board, for example) containing information used to calculate income tax or other taxes. Tax returns are generally prepared using forms prescribed by the IRS or other applicable taxing authority.
TORT:A tort, in common law jurisdictions, is a civil wrong. Tort law deals with situations where a person's behavior has unfairly caused someone else to suffer loss or harm. A tort is not necessarily an illegal act but causes harm and therefore the law allows anyone who is harmed to recover their loss. Tort law is different to criminal law, which deals with situations where a person's actions cause harm to society in general. A claim in tort may be brought by anyone who has suffered loss. Criminal cases tend to be brought by the state, although private prosecutions are possible.