Corporations are all defined by a certain criteria shared by all such companies, namely:
- Corporations are owned by investors, who purchase shares on the stock market. These shares of stock confer a percentage of ownership in the corporation.
- Though the corporation is owned by investors, its day-to-day operations are managed by a board of directors, elected by the investors themselves.
- The investors have limited liability in the corporation. This means that they are only responsible up to the amount of their investment. Their personal income and property is not in jeopardy even if the company were to fail.
- The company exists as a separate legal entity, meaning that it can sue or be sued as if it were an actual person.
These four characteristics describe virtually all corporations, with a few exceptions (closely held corporations, for example, do not have shares sold on the stock market). However, the US tax code has different chapters based on whether the corporation meets certain criteria.
Generally speaking, S corporations do not pay any taxes. Instead, the losses or dividends are split amongst the investors, who will then pay taxes depending on that income. This avoids the problem of double taxation, which would occur if the corporation were taxed, and then the investor were taxed on the money he or she received from the investment. If that occurred, the same money would be taxed twice. These S corporations are much more regulated than their C counterparts. They can have no more than 100 investors, must be owned by US citizens, and can only issue one class of stock.
Most larger companies are C corporations (as are many smaller smaller companies). C corporations pay taxes as a separate entity, which can often lead to the problem of double taxation. If a corporation cannot meet all of the requirements for S corporations, it is automatically a C corporation.