What is the difference between a California Close Corp, an S-Corp, and a C-Corp?
In business discourse, particularly in California, one may hear the terms S Corp, C Corp, and Close Corp thrown around, sometimes interchangeably. However, each of these terms has a distinct meaning. This article seeks to explain each term and their implications to a California business.
What is a corporation?
A corporation is a fictional legal entity used in the United State to engage in lawful businesses. As a fictional entity, it is treated distinct and separate from the underlying shareholders who own its assets. It is designed to promote business activity by offering the shareholders limited liability for their business related conduct. Some other forms of legal entities include limited liability companies and limited partnership. Each state has its own laws concerning the creation and governance of corporations created under its laws.
What is the difference between S Corp and C Corp?
Under California corporation laws, there is no reference made between an S Corp or a C Corp. These terms came to use because of the IRS’s option to allow corporations that meet certain requirements to be treated differently for tax purposes. The term S Corp finds its roots in reference to Subchapter S of Chapter 1 of the Internal Revenue Code (26 U.S.C. §§ 1361-1379). In reference to this, corporations that elected to be treated under provision of Subchapter S were referred to as S Corp. To distinguish between corporations that did not make this election, the term C Corp became common. One of the requirements for keeping the S Corp status is having no more than 100 shareholders.
Choosing to be treated as an S Corp has several tax advantages, such as allowing the corporations income and losses to pass through to the shareholders. This allows passive investors to deduct losses of a new corporation against their personal income.
What is a Close Corp?
In California, a Close Corp refers to a statutory based form of corporation that is specifically provided for under California corporation codes section 158, which in pertinent parts states: “(a) ‘Close corporation’ means a corporation, including a close flexible purpose corporation, whose articles contain, in addition to the provisions required by Section 202, a provision that all of the corporation’s issued shares of all classes shall be held of record by not more than a specified number of persons, not exceeding 35, and a statement ‘This corporation is a close corporation.’”
The Close Corp is similar to a partnership in its formalities. It is ideally designed for a family based type of business with few shareholders. Close Corps are mostly exempt from formalities that are the basis of alter ego liability in regular California corporations. Managers have more flexibility in making decisions without a board of director approval. The decision to be treated as a Close Corp will not impact a corporation’s right to be treated as an S Corp for tax purposes, however there are tax consequences on choosing to be treated as a Close Corp as well, such as inability to deducts payments made by a corporation in connection with stock reacquisitions.
A person contemplating forming a new business should be mindful of the tax and legal consequences in choosing the business entity. For example, if the new business is anticipated to incur a loss at the beginning, a Close Corp with an S Corp election might be best. This allows the shareholder to deduct the losses. However, if raising capital and shareholder growth is in the company’s vision, a C Corp would likely be the better entity form. This will provide a centralized management and allow the corporation to have a large number of shareholders. In both case a legal and tax professional should be consulted.
Jafari Law Group
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