Business Law 101: Understanding the Difference Between Virginia S-Corps and C-Corps

Businesses come in all sorts of shapes and sizes—sole proprietorships, partnerships, LLCs, LPs, corporations, and more. If you are considering forming your company as a corporation, you will have to understand the important differences between the C-corp and the S-corp.  C-corp and S-corp are tax filing statues that are governed by the IRS. There are advantages to being an S-corp, but there are restrictions on using that status as well. In this blog, we will lay out the general basics. However, it’s important to note that each situation is different and you should consult with an experienced Virginia business attorney to ascertain which kind of corporation (if that) is ideal for you.

When you apply to incorporate your business in Virginia, it will automatically be a C-corporation. It’s important to understand that a corporation will never automatically be an S-corporation. The change to the “S” status can only happen when all shareholders give their consent to do so with the IRS by filing a form 2553. The change to “S” status can happen any time after the incorporation as long as the corporation maintains its eligibility—that means you can change to “S” status immediately, or years into the future. Keep in mind though that you can still change back to “C” status by filing a request with the IRS. Once you change back to a “C,” you can’t change back to an “S” for 5 years.

To form a corporation in VA, you must file articles of incorporation with the State Corporation Commission. Attorney Jim Wilson can and will help you get your ducks in a row when it comes to forming your business. Once the corporation is formed, then a filing is made with the IRS to be treated as an S corporation for tax purposes.

How are S-corps and C-Corps the same? In the way that they are governed, liability, ownership, and the way they generate capital, S-corps and C-corps are essentially the same.

How are S-corps and C-Corps different?

  • In a classic C-corp situation, the corporation is treated as a separate taxable entity from its owners/shareholders by the IRS.
  • The C-corp is taxed at the corporate tax level and its shareholders are taxed at the personal income level after they receive their dividends from the business. The IRS essentially gets to take two bites out of the C-corp apple. This is called “double taxation.”
  • S-corp shareholders do not pay self-employment taxes on profits of the S-corp.  While this provides some savings in the near-term, by not making contributions now to Social Security through the self-employment tax, social security benefits S-corp shareholders eventually will receive will be less than they might have been.
  • On the other hand, the S-corp is treated as the same entity as its shareholders when it comes to taxation. Any incomes and losses sustained by the business get “passed through” to the personal income tax of its shareholders. There is no tax at the corporate level. Taxes only come from the personal income tax rate of the shareholders.
  • S-corps are allowed to have only one class of stock, while C-corps can have many classes of stock.
  • It’s more difficult to raise venture capital for S-corps than it is for C-corps.
  • A C-corp can have an unlimited number of shareholders, while S-corps can only have 100 or fewer shareholders.
  • S-corp shareholders must be U.S. citizens or residents, while C-corp shareholders can be U.S.-based or foreign.

It is important to note that the S-corp election is a tax status and is available to any kind of entity.  An LLC can be an S-corp for tax purposes, so can a partnership, even a sole proprietorship. This is something that needs to be discussed fully with an advisor before making the election.

As you can see, the decision to change to “S” status can impact several aspects of your business or shareholder status. Which one is the better option for you? And with the passage of the Tax Cuts and Jobs Act, there are even more considerations you should be discussing with a qualified business attorney in preparation for tax season this year. Let Attorney Jim Wilson walk you through this crucial decision. Please call the office today at 804-864-5268 or contact us here.

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Wilson Law Group

Jim Wilson is the founder and principal attorney of the Wilson Law Group. For the past 25 years he has been combining legal dexterity with an entrepreneurial mindset to help aspiring and established business owners start, finance, buy, sell, and run their companies.

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