Piercing the Corporate Veil
However, it is worth mentioning that the protection provided by the C corp formation is not an absolute protection. A court can “pierce the corporate veil” if it finds that the corporation was not adhering to corporate formalities and was using it to avoid liabilities and commit fraudulent acts. If the corporate veil is pierced, then the shareholders’, members’ or owners’ personal assets can be reached. Small corporations are more likely to have this happen as it can be more difficult for them to keep up with all of the formalities. An important and easy way for small corps to avoid any piercing is to avoid comingling of assets and to keep the accounts and assets of the corporation completely separate from individual accounts. Those corporate accounts must never be used for personal reasons.
Because a corporation is its own entity, it can continue to exist long past the original shareholders lifetimes, since shares can freely be transferred. Transferring shares has less and easier to understand tax implications than the transferring of a partnership or proprietorship interest. It does not matter if a shareholder, director or officer leaves the company, or dies. A deceased shareholder’s shares go to the heirs of the shareholder quite easily. The corporation will continue on and can only end when it is dissolved by the shareholders. So in essence, the corporation can exist indefinitely. This is a major advantage as it provides stability and is more attractive to investors. The longer the corporation exists, the better likelihood of success and a return on investment.
The S corporation has all the benefits of a C corporation previously discussed: personal assets of shareholders are protected, attractive to investors, organizational structure and perpetual existence. However, the major reason that corporations choose the S form over the C form (if they are eligible) is because of the tax advantages, which is the major difference between an S corp and C corp. The benefit to an S corporation is in the way in which they are taxed. The first benefit is that S corporations only have a once a year tax filing requirement while C corps are required to file quarterly.
The second tax benefit is in how S corps’ revenues are taxed compared to C corps. C corporations are taxed twice. The first taxation comes at the corporate level and then there’s a second taxation at the shareholder level. The S corporation’s revenue is only taxed once – the taxation is not based at the corporate level but instead, only at the shareholder level. Taxation happens when shareholders receive dividends or when it is paid out in salaries. This is what is called a “pass through” taxation, as it passes through the corporate level. In this way, S corps are taxed similar to LLCs. This alone can save a corporation many thousands of dollars. However, because of this advantage, S corps are more highly scrutinized by the IRS. Salaries paid out to shareholders must be “reasonable.” Having a good accountant is crucial as any misreporting can cause an S corp to become a C corp. An S corp may want to drop its S status and become a C corp in the future if it becomes more profitable and there may be more tax advantages in the C corp formation.
While this is the main difference and benefit between a C corp and an S corp, it is worth consulting your state’s tax laws as a handful of states will still tax an S corp like a C corp at the state level. This is important when choosing which state to incorporate in.