C-Corp vs. S-Corp: Understanding The Basics

A corporation is a legal structure preferred by venture capitalists, angel investors or others looking to invest substantial capital in a new or emerging company. If the company conducts considerable amounts of business nationwide and even internationally, its intricate operating structure will need an appropriate bureaucratic overlay to adequately manage its varied operations. A corporation is the most complex of the for-profit business organizations. In that sense, a new company that is growing into operational efficiency may find it more feasible to start with a partnership or LLC and see whether future success justifies transformation to a corporate conglomerate.  Importantly, certain tax choices must be made when the business formation process begins.

You may have heard it said that the corporate legal structure suffers from the method of taxation known as double taxation. In the less complex business structures, such as the partnership and the LLC, the partners or members pay taxes only once and this occurs on their personal income tax return. The income from the business is “passed through” to the individual’s personal return without that income first being taxed by the IRS at the business level. Thus, with the sole proprietorship, the partnership, and the LLC, each of these entities is not taxed on income coming into the business and then to the individual on his or her personal return. Instead, the income of the business is subject to one tax only.

The C-Corp Method of Taxation Applies by Default

By contrast, the C-corporation (C-corp) is taxed by its earnings at the corporate level when it files an applicable corporation tax return. The profits then get distributed to the shareholders, usually in the form of dividends, which are reportable on the shareholder’s personal income tax return, thus making the same funds twice liable for income taxes, on the corporate and on the personal individual level. The IRS assigns the newly filed corporate entity a C-corporation tax status by default. The C-corp, therefore, represents the classic double-taxation practice that shareholders try to avoid where possible.

S-Corp Status Offers Advantages for Smaller Corporations

For companies with one hundred  (100) or fewer shareholders that have no intentions of going public anytime soon, electing S-Corporation (S-corp) status is available pursuant to Subchapter S of the Internal Revenue Code. An S-corp is not subjected to double taxation. Instead, each shareholder reports corporate income on his or her personal income tax return but the S-corp does not pay income tax at the business level. The S-corp thus provides the same kind of pass-through tax method enjoyed by the proprietorship, the general partnership, and the LLC.

Other conditions apply for S-corp status. For example, the S-corp cannot have a non-resident alien as a shareholder. It cannot issue more than one class of stock and is limited in the amount of capital that it can raise. If qualified, the S-corp may operate with fewer formalities than the C-corp. The C-corp does have certain advantages over the S-corp. It can accept foreign investors legally and is thus a stronger investment vehicle. It is not limited in the number of shareholders, the classes of stock issued, or the amount of capital invested. It is the model that must be used when transforming to a public offering.

What Is A Close Corporation and How Can It Help?

If the company has a relatively few shareholders (owners) and is restricted to a limited group of investors, or where it consists of only one, two or a few shareholders, it may file and organize itself as a “close” corporation. The entity can be both an S-corp. and a close corporation. The shareholders must agree unanimously to be organized as a statutory close corporation pursuant to Maryland law. For example, where the company intends no public offering at any time soon and it will be owned by a relatively small number of shareholders, the owners may set it up as a “close” corporation, while also electing to be taxed as an S-corp.

2017 Maryland Code, Title 4, is the statutory provision that authorizes the creation of a close corporation by the shareholders. After formation, the close corporation’s shareholders can agree to abolish the board of directors and operate the company themselves. Maryland law specifically requires that the stock shares and certain other business forms, such as the articles of incorporation, must indicate clearly that the company has been organized as a close corporation and that restrictions are applicable.

One important restriction of a close corporation is that the shares of stock must be first offered to the existing owners and to the corporation prior to marketing them to the public. Remember that the S-corp is different than a close corporation although the two concepts share some similar characteristics. The S-corp refers to a method of taxation as does the C-corp. A close corporation serves different purposes and follows the Maryland statutory mandates.

Some of the foregoing issues are complicated by exceptions, qualifications, and numerous considerations under federal and Maryland law. A business law attorney and a tax consultant are the two main professionals that will guide you through the complexities of business organizations. An attorney can also help if the company has chosen S-corp status and wants to switch back to C-corp status. The S-corp election is made on IRS Form 2553, which all stockholders must sign, and the form must be filed with the IRS.

If you need advice regarding any business formation issue, please contact Maryland business law attorney Elsa W. Smith at the Law Offices of Elsa W. Smith, LLC.  We have two offices to serve you: Annapolis and Laurel. You may also contact us via our website.

small business


A business may be operated under one of several available business structures. Choosing the right structure for your company is one of the most important decisions you will make because it impacts how the entity is taxed, an owner’s personal exposure to liability and the ability to raise investment capital or loans. It also affects the level of government oversight along with reporting and paperwork requirements. Maryland state law defines and regulates each type of business model making it important that the business know and understand the legal rules that apply.

The four most popular business structures in Maryland and nationwide are the Sole Proprietorship, General Partnership, Limited Liability Company (LLC) and the Corporation. There are other structures that are also available. Because the business must comply with governmental requirements, organizational imperatives and tax procedures, the best place for a new or growing company to evaluate and select its best business model is at the office of an experienced business law attorney.



Sole Proprietorship

The simplest and most common form of business structure is the sole proprietorship.  This comprises one individual in business as the sole owner. There is no legal separation between the owner and the business, meaning that the proprietor is the business for legal purposes. A sole proprietor enjoys total control over the management, development, marketing, and daily functioning of the business. This model offers ease of operation, few regulations, less reporting, and an easy method of taxation.

With all of that apparent business simplicity, one might question why a small business owner would not choose to operate under a proprietorship. The answer is that there are critical disadvantages, including that the owner is personally liable for business debts. This means that the owner’s personal assets may be attached and seized to satisfy business debts that are reduced to a judgment. Notably, this applies to all kinds of debts including personal injury or wrongful death awards, which can sometimes be huge. It is also difficult for the sole proprietorship to grow because investors will generally not consider this structure for assistance.



A General Partnership consists of two or more persons operating a business together for profit. Each partner contributes money, expertise, working labor, or a combination thereof, to the company. Each partner shares in the profits, losses, and business debts according to his or her percentage of ownership.   Partnerships are easy to form, they do not require many formalities, and there is generally simple taxation. Their informality makes this a viable choice in some cases where the partners want to first see whether the business concept will be successful.

The biggest drawback is that the partners are not given limited liability. Maryland, however, provides partnership models that do provide limited liability. The Limited Partnership (LP) is a more complex structure that usually has one general partner and several limited partners. The general partner has unlimited liability, whereas the limited partners risk only up to the amount of their investment. Limited partners do not usually join in the company’s management.

Maryland also provides for a Limited Liability Partnership (LLP), which provides limited liability to all of the partners. This structure is available for professional practices, such as lawyers, accountants and doctors who practice together.


An LLC combines features of both a partnership and a corporation.  Unlike the sole proprietorship or the general partnership, the owner of an interest in an LLC, called a member, enjoys limited liability and is protected personally from the debts of the business. Additionally, the LLC offers “pass-through” taxation, fewer regulations and broad flexibility.  The LLC, which has become popular in recent years, is governed by an operating agreement.

Flexibility of an LLC includes optional forms of taxation, various management models, and creation of hybrids that mix qualities of different business structures together. For example, the operating agreement can specify that the business will be run by a manager or it may be set up as a member-run organization.  The LLC is disadvantaged in that it is not suitable for raising large amounts of venture capital or attracting investors for a public offering.


A corporation is owned by the shareholders, operated by the board of directors, and managed by the officers. It must have meetings and must follow strict procedures for taking corporate action. A corporation’s stock shares may be sold to the public if all of the considerable legal hurdles are satisfied. Most corporations, however, are privately owned.  These smaller private companies usually have a shareholder agreement restricting share transfers to outsiders.

A corporation exists perpetually and enjoys limited liability for its shareholders. A smaller business can elect a special “S” status which simplifies taxation. Also, Maryland law provides for a “close corporation,” which is designed for smaller companies limited to a certain number of shareholders. This model has reduced formalities and may be set up without a board of directors. Maryland also allows certain non-stock corporations, usually for charitable and non-profit organizations.

A corporation is the choice of large companies that operate nationally and internationally, and that can attract large investors to finance rapid growth and a public offering. A disadvantage is that it suffers from an overabundance of paperwork and government regulations. It is the costliest structure to start and to maintain. The disadvantages, however, are accepted as a cost of business success.

In the final analysis, choosing a business structure here in Maryland is a complex process involving several competing factors. The personalities, aspirations, experiences and goals of the owners may color the ultimate choice of business structure. When a business structure has to be changed, the business attorney will guide you through the process. Sometimes, that is a cost of growing the business, which makes it a pleasant transformation more than an unwanted expense.

For guidance in selecting the appropriate structure for your business, contact Maryland  business law attorney Elsa W. Smith at the Law Offices of Elsa W. Smith, LLC.  We have two offices to serve you – Annapolis (410) 995-7719 and Laurel (301) 358-4340.  You can also contact us through this website.