Corporations are creatures of State statute and must be formed in compliance with State law. Corporations provide liability protection to its shareholders. Further, after incorporation the entity maintains additional compliance obligations with the State in order to preserve its status. Shareholders are allowed to be active in the management of the corporation (either as an officer or through the election of directors, who then elect the officers who run the corporation), without risking their limited liability (unlike a limited partner in a limited partnership who becomes an active participant).
While subchapter C and subchapter S are classifications of corporations, there is no legal difference between the two types. Rather, the distinction between the two types relates to tax treatment only. A C-Corp is taxed at the corporate level and the income to shareholders is taxed at the personal tax return, resulting in “double taxation”. The corporation doesn’t get a deduction from its income for distributions or dividends paid to its shareholders. A C-Corp may have multiple classes of stock, although all shares within a class must be treated the same.
A “S-Corp” may avoid double taxation if it meets these qualifications: (1) it’s organized under the law of a U.S. State or territory; (2) the shareholder may only be an individual, estate or certain types of trust – partnerships and corporations cannot be shareholders; (3) only U.S citizens or residents may be shareholders; (4) only one class of stock permitted; (5) no more than 75 shareholders permitted. If these requirements are met, then the IRS will agree that the shareholders will report their share of the corporation’s net income on their personal Form 1040; consequently, there will be no taxation at the corporate level and double taxation is avoided. A downside to sub-S treatment is that the shareholders pay tax on their proportionate share of the corporation’s net income whether or not the income is in fact distributed to the shareholders. Because only one class of stock is permitted in a S-Corp, and all shares within a class must be treated the same, “special allocation” of losses is not permitted.
Corporations are generally subject to state franchise taxes (but partnerships, including LLCs, are not). Generally, distributions to shareholders are considered “passive” income, and are not subject to self-employment tax; however, the IRS gives scrutiny to whether the corporation is paying a reasonable amount of salary (which is subject to self-employment tax) to the owners, in relation to the amount of distributions or draws that are taken.
The entity must include the designation “Corporation”, “Corp.”, “Company”, “Co.”, “Incorporated” or “Inc.” in its name.