When you make the decision to start a business, it opens the door to a new beginning and endless possibilities. You’ll have your fair share of decisions that need to be made, one of the most important of those is how to set up your new business. LLC, C Corporation, and S Corporation are among your options.
While some may find the LLC structure to suffice, others will choose between an S Corp vs a C Corp. Attorneys might be able to help with ideas on what the implications of choosing one over the other are. Others who own businesses could share their experiences with you. Ultimately, though, you’ll need to make a decision based on your business goals.
Choosing the right option when starting your business is important as it will save you from a lot of headaches in the future. Understanding how each of them works and their differences will help you make the right choice for your business. So, what is the difference between a c corp and an s corp? Let’s dive in so you can find out and see which is the right choice for your business.
What is a C Corporation?
A C corporation is a business structure that is a separate entity that can enter into contracts, own property, sue or be sued, is taxed separately, and can invest and lend money. C corporations and their owners are treated as two different individuals. Shareholders are the business owners of C corporations.
These shareholders will elect a board of directors who will make decisions on how to run the company. The board of directors in a large corporation will appoint the day-to-day management of the company. Smaller corporations will typically have these board members also part of this management team.
C corporations can be privately held or publicly held companies. A publicly held company will sell shares of the company to the general public. As a result of this, these companies must disclose their financial information. Privately held companies don’t sell shares of their company to the general public and therefore are not required to share their financials.
What is an S Corporation?
“Subchapter S corporation”, or S corporation for short is also referred to as “Small Business Corporation”. Enacted into law by Congress in 1958, S Corps are intended to help support and motivate family and small businesses. So an S corporation is actually an elected tax status, not a business entity.
Having an S corp tax election tells the IRS that your business should be taxed as a partnership. This prevents double taxation from occurring. Just like in C corps, your business owners are called shareholders. You’re considered an employee when you’re a shareholder (owner) and are required to take a salary.
All profits, losses, deductions, and credits from the S corp are taxed on the shareholder level. You must have at least 100 shareholders to qualify for an S corporation. Additionally, you must file with the IRS as an American corporation and your business must be located in the United States.
How are C Corps and S Corps Similar?
When evaluating an S corp vs C corp, they have more that makes them similar than different. Below are what traits that these two business structures have in common.
Protection from Liability
S corporations and C corporations both offer shareholders liability protection. This limited liability protection is possible because both of these corporations are legally separate from their owners.
Hence, if the company accumulates business debts or other liabilities, shareholders are not held responsible. Limited liability is a big selling point of turning to a corporation. The exception to this if the company does not keep compliant.
To have a corporate business structure, there must be a breakdown between shareholders, directors, and officers. This makes an S corporation and C corporation different from an LLC. Each person has a different role within the company:
- Shareholders are the owners of the company and elect the board of directors
- Directors oversee the bigger business issues including decision-making, goals, and affairs. They are also responsible for electing officers.
- Officers are the day-to-day managers of activity within the business
Documents and Compliance
There are specific documents that C corps and S corps must file with the state’s governing entity. This typically will include the Articles of Incorporation. Sometimes these are referred to as the charter documents. The name and address of the corporation, business purposes, signator for signing articles, and agents that can accept legal service of the process for the company are often items that are part of this document.
C corps and S corps also have additional obligations to fulfill including:
- Issuing stock
- Paying fees
- Adopting and enacting bylaws
- Holding shareholder and director meetings
The Difference Between C Corps and S Corps
A business owner should understand the differences between the S corporations and C corporations for guidance on which path to take. Since choosing the business entity type is such an important decision for businesses, one should seek the advice of a lawyer as well. Here are the differences that owners should consider between these two corporations.
The tax differences between an S corporation and a C corporation are the first major differential. Double taxation occurs when a business chooses the C corporation status. The company must pay corporate income taxes and shareholders will also pay federal income taxes on dividends.
C corporation owners are also typically employees, employed in executive positions. They must pay income tax on their salaries that they receive as personal income.
There are only two ways to avoid this double taxation in C corporations. The first is if there are no profits after company revenue and expenses have been accounted for. The other way if the profits are reinvested into the corporation, instead of dividends.
The difference with S corporations is that it uses pass-through taxation. How this type of taxation works is that shareholders report their business income and losses on their personal income tax return.
Each year, an S corp will send S corporation owners a Schedule K-1. This will show how much personal returns that the individual has been allotted. K-1 income must be submitted with their personal tax returns. The profit and losses are added to their personal tax as either income or deductions.
By doing this, only their personal income tax returns will be faced with taxes. Since there are no corporate taxes, shareholders avoid double taxation.
The next major difference between C corporations and S corporations has to do with corporate ownership. When it comes to who are the owners of a company, there aren’t any restrictions with C corps. You can have as many shareholders as you want and anyone can be a business owner. This also applies to the different classes of shareholders.
What’s important to know about this key difference is that venture capital firms and angel investors prefer holding preferred stock in a corporation. C corps have options including this one class of stock. That makes fundraising much easier with C corps.
A C corp could be the better choice if you plan to sell your business later or spin-off a subsidiary. That’s because an S corp can’t be owned by a C corp, LLC, general partnership, or most trusts. C corporations don’t have this restriction and can be owned by another corporation, LLC, etc.
You can have up to 100 shareholders as an S corp. Additionally, your shareholders must be United States citizens or resident aliens. A C corp allows foreign investors to become shareholders.
There is only one class of stock with S corps, which means there’s only one type of shareholder. Since there are no differences or hierarchy between shareholders in the business, fundraising is more difficult.
Filing for Articles of Incorporation in a state as a C corp will also designate you with this corp status. That’s because a C corporation is a type of corporation by default.
To receive S corporation status, owners must file a Form 2553. For federal income tax purposes, you will become an S corp after this filing. Other forms might also be required to keep this S corporation status too. For example, you might be filing documents at the state level to cover tax implications at the state level.
Regardless of whether you elect S corporation status or the latter, the process for this corporate formation is similar:
- Step One – File for articles of incorporation
- Step Two – Appoint a registered agent
- Step Three – Create Corporate bylaws
An attorney can help you through these steps to ensure that you are filing the right documents based on the state you’re doing business in. You can also do it yourself.
C Corp and S Corp Advantages
Liability protection is a benefit that you get regardless of whether you elect the C or S corp status. Let’s dive deeper into each to get a S corp vs C corp list of advantages.
Advantages of S Corporations
Limiting your shareholders to 100 isn’t necessarily bad, particularly if the opinions of your shareholders are valuable. Your owners are more involved in the daily operations and provide an opportunity to provide advice.
Arguably the biggest benefit of choosing the S corp status is the taxes. Owners report on their personal tax returns on business income and losses. In most cases, an S corp can deduct up to 20% of their business income on their personal income tax report. Plus the owners of S corporations can write off business losses on their personal tax returns.
Limited ownership is better on an S corp vs C corp. An S corp limited their shareholders to 100 and they must be U.S. citizens. There are no differences in the types of shareholders that own stock in an S corp. So if you don’t have to have a ranking order in your corporation, a S corp will be better.
Advantages of C Corporations
It is easier to form a C corp as compared to an S corp. You’re given the default status of a Corp once you file your articles of incorporation. There is also less paperwork involved in the process.
As long as you don’t go over 10% of your company’s income, you can deduct 100% of your charitable contributions and donations on your corporate tax return. Deducting benefits like health insurance for your employees will also help them by potentially reducing their income tax rate on their personal tax returns.
If the plan for your corporation is to sell in the future or funding through investors, you’ll probably prefer a C Corp. There is no limit to how many shareholders you can have with a C corp.
It’s also easier to sell stock to potential investors as a C corp over an S corp. A c Corp can be owned by other C corps, S Corps, other corporations, etc.
C Corp and S Corp Disadvantages
Both of these corporations also have disadvantages. Businesses should weigh these against their advantages and what their goals are for their companies.
Disadvantages of S Corporations
It is a lot more work to set up S corp status than a C corp. To achieve S corp status, you must file your articles of incorporation, then file additional documentation like Form 2553. Then in some states, there are other requirements to become an S corp. You may need an attorney to ensure you are filing all the documents necessary.
The tax filings on companies that are an S corp are generally watched more than the tax filings of a C corp. The IRS will scrutinize your tax filing as an S Corp so you’ll have to ensure that you’re following the internal revenue code to the letter.
For example, they’ll take a close look at the salaries of officers to ensure they are “reasonable”. If they believe wages have been misreported to reduce their tax burden, they could greatly increase that person’s tax payment.
A good tax attorney and corporate accountant can help assure you are following tax guidelines. Businesses that have mistakes that are discovered by the IRS could face serious consequences. They could even lose their S corporation tax status.
Since you’re more scrutinized by the IRS as an S corp, you need to ensure you’re following all the rules. You must ensure that you keep to your limit of 100 shareholders and that each owner is a U.S. citizen for example.
Since you only have one class of stock with an S corp, your potential for high growth could be hurt. Since S corps can’t be owned by another S corp, C corp, etc, that will affect your potential for selling your business.
Disadvantages of C Corporations
Although this type of corporation is easy to form, requiring you or attorneys to file your articles of incorporation, might not be right for your business. Not every corporation wants to get acquired or funded. Think of the various private companies that are out there.
Becoming a C corporation is a good fit for companies that are already big or want to get bigger. Don’t have your attorneys working on filing your C corp status if you don’t have or want a big company.
The tax disadvantage for C corps is the biggest downfall. You will pay tax on your company’s revenue and also your personal income tax rates.
This double taxation is especially challenging for small business owners. They don’t have deep pockets to cover paying tax twice. On the corporate level, this tax will affect your earnings.
When compared to other structures, C corps are more expensive to set up. It could cost thousands of dollars to get a certificate of incorporation in some cases. There are also ongoing fees that you must pay to maintain your status.
Although you enjoy no ownership restrictions or limits on classes of stock, you’ll need to manage the day-to-day with your business well. For example, you’ll need to know when to issue stock to shareholders and hold regular meetings for shareholders and directors.
C Corp or S Corp: How to Decide for your Business
Whether you’re starting a local real estate business or planning the next tech company, deciding your business structure is important. Discussing these different business entities with an attorney is recommended before making this important decision. It might even make sense to consider an LLC, depending on your goals.
Here are some things to ask yourself.
Do you want limited or unlimited shareholders?
If you have big expansion plans, then C corps will give you room to grow. For a small business, that might not make sense. Filing as an S corp will give you the ability to get shareholder input into decisions.
Do I want to sell my company someday?
A C corporation will be beneficial if you decide to sell your company in the future since they can be owned by other types of companies. Having as many shareholders and different classes will also help with your acquisition goals.
Can my business handle double taxation?
With a C corporation, you’ll have to be ok with getting taxed on the corporate and personal level. Make sure that it’s worth going with this status.
Can I manage to have my taxes scrutinized?
S corporations are subject to being watched closer by the IRS. That means you’ll have to dot every “i” and cross every “t” on your record. You’ll need to avoid even the smallest mistake to avoid the possibility of losing your status.
Remember, the type of company you want to run will ultimately determine how to set up your business. Make sure that it fits with your vision and you’re comfortable with the implications when making your decision.