After the good response about one of the most widely used business entity, I decided to write about the next most popular—corporations. Prior to 1986, a corporation was the preferred business entity for business owners. Two types of corporations exist, S and C corporations. Both are set up the same way in Texas with the Texas Secretary of State’s office; however, the S Corporation requires a filing with the Internal Revenue Service.
First, a C corporation is what most people think of when they think of a corporation. All the income and losses do not flow through to the shareholders; instead the corporation pays the income taxes. The C corporation is an income taxpayer and is responsible for income tax on all of its income. A C corporation is liable for the Texas Margin Tax and there are no self-employment taxes on any dividends paid by the C corporation to the shareholders.
Most companies, however, do not operate as a C corporation because of the double taxation nature of the entity. As stated, the corporation is taxed on its income and then the shareholders are taxed on their dividends or liquidated distributions. Nonetheless, the advantages of the C corporation (much like a S corporation) are that the shareholders are not liable for the debts of the corporation absent a personal guarantee. Clearly, so long as the shareholders observe the corporate formalities, the shareholders will have limited liability.
Next, an S corporation acts much like a C corporation other than the income and deductions flow through to the shareholders based upon their stock ownership. An S corporation is a federal tax law classification and therefore, in order to qualify and elect to be an S corporation, the business owners must satisfy the federal income tax rules attributable to it. This includes limiting the number of shareholders (no more than 100) and the type of shareholder who can own S corporation stock (U.S. citizens and resident aliens, estates, certain trusts and another S corporation provided it owns 100% of the subsidiary S corporation).
Additionally, S corporation rules require there only be one class of stock. The S corporation rules do allow differences in voting rights, thereby allowing you to have a class of voting stock and nonvoting stock.
An S corporation has been a valued entity for close corporations and family companies.
To file either a C corporation or an S corporation, you must file articles of formation (formerly known as Articles of Incorporation) with the Texas Secretary of State and pay the required fees (currently $300).
Finally, be sure to understand wholly the liabilities and debts that your company may fact to help you decide whether to choose a corporation as you entity of choice.
Editor's note: The information in this column is not intended as legal advice but to provide a general understanding of the law. Readers with legal problems, including those whose questions are addressed here, should consult attorneys for advice on their particular circumstances.
