In forming a corporation, prospective shareholders exchange money, property, or labor (sweat equity)—or some combination of those assets—for the corporation's stock (shares of ownership). A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. A corporation conducts business, realizes net income or loss, pays taxes, and distributes profits to shareholders.
For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity—separate from the shareholders. The profit of a C corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.
In contrast, an S corporation is known as a flow-through entity, as it does not pay income taxes. Instead, all income flows through to the shareholders based on their proportional ownership, who pay income tax on the corporation’s income. The shareholders of both C corporations and S corporations are not personally liable for the debts and other obligations of the corporation.
In Texas, forming a corporation involves prospective shareholders exchanging assets such as money, property, or labor for shares of ownership. The corporation is treated as a separate entity for tax purposes and can take deductions similar to a sole proprietorship, along with special corporate deductions. A C corporation is taxed on its profits at the corporate level, and dividends distributed to shareholders are also taxed, leading to double taxation; the corporation itself does not receive a tax deduction for these distributions. Shareholders cannot claim losses of the corporation on their personal tax returns. Conversely, an S corporation is a pass-through entity, meaning it does not pay corporate income tax. Instead, profits and losses pass through to shareholders, who report them on their personal tax returns and pay the corresponding tax. Shareholders of both C and S corporations enjoy limited liability, meaning they are not personally responsible for the corporation's debts and obligations.
