When forming a professional corporation, you might well face this popular dilemma: S-Corp or C-Corp? What is the difference between a C-corp and S-corp in California, anyway?
When examining this question, most multi-member or sole proprietorship owners tend to lean toward a corporation with lesser taxes, which is understandable. However, there are other factors private practices should consider as well. For instance, S-corps face certain restrictions while C-corps don’t. What are these restrictions, and how do they affect your choices?
Read further to find out the perks and downsides of both corporations and the difference between California professional corporation C-corp and S-corp in California. Armed with the right information, you can choose the right structure for your professional corporation with confidence.
What Is a California Professional Corporation?
California doesn’t permit certain professionals to form limited liability companies (LLCs. Instead, licensed professionals in these professions must create a professional corporation instead of a typical traditional corporation. These professions are:
- Medicine (this includes medical doctors, physician assistants, nurses, physical therapists, etc.)
- Psychiatry (including family therapists)
- Dentistry (including dental assistants)
A California professional corporation is like a regular corporation except for certain requirements relating to these professions. It’s essentially a type of corporation where professionals of a single profession provide professional services in their field. For example, doctors can band together to form their own clinic under a professional corporation.
A professional corporation also benefits from additional advantages such as personal liability protection and financial liability protection. It can be a foreign or domestic corporation, and it isn’t restricted to one corporation tax status. Once you have your professional corporation active and running, therefore, you can think about becoming either an S-corp or C-corp as described below.
What Is an S-Corp?
Although a professional corporation is a type of business entity, an S-corp is a tax framework open to certain LLCs and corporations. The S-corp is named after Subchapter S of the Internal Revenue code. Its taxation is similar to those of limited partnerships, and the core of an S-Corp is built on “pass-through” taxation, which can have employee and self-employment tax advantages.
According to the IRS, S-corps are qualified corporations and pass-through entities. This means they pass income, taxes, credits, and deductions of the corporation through to the company’s shareholders for federal tax purposes.
In a nutshell, this means S-corps don’t pay federal corporate income tax. Rather, the IRS taxes the dividend income at only the shareholder’s level.
With an S corporation election, the IRS taxes your corporation as a limited liability partnership. The tax liability works under a marginal income tax rate. This corporate tax rate is between 10% to 37%.
Since an S-corp is a corporation, its owners and corporate officers can enjoy corporate liability protection. An S-corp has a different life from its owner, so if an owner leaves, it doesn’t affect the corporation’s longevity as it might with other business entities. However, at the same time, an S-corp doesn’t allow you to claim tax benefits on any business expenses you’ve incurred.
What Is a C-Corp?
A C-Corp is the default tax designation of professional corporations and is the most used. Just like S-corps, C-corps got its name because it is obliged to the subchapter C of the internal revenue code. S-corps and C-corps aren’t different under California’s corporation laws, but they are different under the federal tax code’s regulatory requirements.
Contrary to the S-corps, a C-corp is a legal framework of corporations where the owners/shareholders are taxed independently of the legal entity. They are also liable to corporate income taxation. This means C-corps are bound by double taxation.
C-corps file a Form 1120 (corporate tax return) and pay their federal taxes on the corporate level. After the corporation has been taxed for federal corporate taxable income, the corporation gives dividends to its owner from the taxed income. The owners then pay their income taxes or personal tax return. Both the corporation and the owners must pay taxes for federal purposes.
As with S-corps, C corporation status comes with the distinct advantages of being a corporation. Since they are an entity separate from their owners, owners enjoy limited liability protection where their personal assets can’t be used to settle business debts. A shareholder leaving the corporation also isn’t an issue; it’s a separate entity from the owner.
Notable Difference Between a C-Corp and S-Corp
Obviously, the big difference between S-corp and C-corp structures in California has to do with taxes. However, these differences have effects on many other areas of the way these corporations work. In this section, we’ll go over some of the key differences between a professional S-Corp and a professional C-Corp in California.
The IRS demands that S-corps employees and owners are paid wages instead of treating the distribution of their shares or another form of dividends as payments. Additionally, the salaries paid should equate to the work these individuals perform. This also means they are subject to payroll tax at a personal tax rate.
At a corporation level, C-corps are the default type of tax designation for professional corporations. Hence, you are appointed a C-Corp when seeking to form a corporation unless you fill out additional forms.
Profession S-corps are created when you file Form 2553. Your financial officer may also have to fill out other forms to retain that designation
Is your corporation located out of the country? Contact an appropriate document preparation agency to learn more including foreign corporations.
Professional C-corps have restrictions when it comes to ownership. Anyone can own a C-Corp as long as it’s not connected to a professional corporation. Additionally,
there is no limit to how many owners a professional C-corp corporate entity can have. However, that’s not the case for professional S-corps. S-corps can’t have more than 100 shareholders, and they must all be US citizens. The shareholders get to elect the board of directors.
Shares of Stock
For professional corporations, there are some shareholder restrictions and additional requirements. Professional S-corps can’t have more than one class of stock, and you can issue your stock in form of preferred stock. A professional C-corp can have multiple classes of stock, however.
Professional C-corps provide more flexibility than S-corps when it comes to the number of owners or professional employees. Hence, a C-corp is more suitable for large companies with lots of licensed persons/shareholders. Individual shareholders also have voting rights, and they can make major decisions for the domestic corporation.
C-corps worth more than $5,000,000 in gross receipts must use the accrual method of accounting. In contrast, only S-corps with an inventory of business assets may use the technique.
The ending of a C-Corp fiscal year is flexible. However, the fiscal year-end for S-corps must end on December 31st. If a C-corp uses a fiscal year-end other than December 31st, when it changes to an S-corp, it must change its fiscal year-end to December 31st. Nonetheless, this logic doesn’t apply to an S-corp that changes to a C-corp, as the corporation sticks with the S-corp’s fiscal year.
How to Convert From an S-Corp to a C-Corp And Vice Versa
What if you used the wrong corporate structure in your articles of incorporation process and you’d like to switch? Luckily, this is an option for you. You can form an S-corp by filing Form 2553 with the IRS even if your professional corporation is a C-Corp.
An S-corp can become a C-corp if you file a formal request with the IRS. However, once you make the switch from S-corp to C-corp, must be at least a 5-year wait before it can become an S-corp again. This is so that corporations don’t switch between taxable years to exploit pass-through taxation and save payroll taxes.
Form a C-Corp or S-Corp Professional Corporation with A People’s Choice
You must first form a professional corporation before deciding which tax designation to choose. Once you’ve created your professional corporation, you can choose between an S-corp and C-corp for your business. Both S-corp and C-corp types of business entities come with their benefits and their downsides. However, one of the options likely has better fringe benefits for your corporation situation. And if you start with one of the options and don’t like the outcome, you can always change.
Incorporating in California involves several documents, which can be overwhelming. Filing to be a C-corp or S-corp business structure requires additional paperwork, and hiring a lawyer to prepare all this is unnecessarily costly. that’s where A People’s Choice steps in.
A People’s Choice is a Californian document preparation platform. A People’s Choice cannot provide legal advice, but we do have years of experience when it comes to incorporating in California. We can help you complete your paperwork for single-member LLCs, sole proprietors, professional service corporations, a professional law corporation, and much more. Contact A People’s Choice here to get started on setting up your corporation structure!
I own several commercial properties that I wish to place an LLC designation (to conceal my name).
Would you be kind and advise me what would it cost to do that, Please?
Stevan Dweck email: firstname.lastname@example.org
We would be happy to help you start up an LLC. Please contact our office at 800-747-2780.