The Practical Tech Lawyer: Should Your New Corporation Be a C Corp or an S Corp?

Okay, let’s assume you’ve ruled out forming your business as an LLC. You’ll use a corporation. So do you elect “small business corporation,” otherwise known as “S corporation” status the Internal Revenue Code (beginning with IRC section 1361), or fall back on the default “C corporation” status (meaning any corporation that isn’t an S corporation)?

In almost every case I can imagine (leaving aside tax situations where shareholders don’t want to receive corporate losses on their own tax returns), I recommend you start with an S corporation election and enjoy the advantages of pass-through taxation as long as you can. All stockholders of the company must agree to make the election, so if you don’t have unanimity among the owners about this, your company will automatically be taxed as a C corporation.

How do you know if your company qualifies? See www.irs.gov/pub/irs-pdf/i2553.pdf.

When the company no longer qualifies for S corporation status (taking on an investor that is not a human being, such as a VC firm, or allowing a non-resident alien to buy stock, or creating a class of preferred stock), you’ll lose your S corporation status and the corporation will begin to pay taxes on profits (or will accumulate losses) at the corporate level as a C corporation. A majority of stockholders can also elect to terminate S corporation status at any time.

© 2012 by Robert G. Schwartz, Jr. All rights reserved Disclaimer: This summary is provided for educational and informational purposes only and is not legal advice. Any specific questions about these topics should be directed to an attorney.

SOLOWAy | Schwartz

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