C Corporation vs S Corporation: What is The Difference?
When you’re deciding how you want to run your business, you have a few options. Some people will choose to set up an LLC, while others will look into setting up an S corporation or a C corporation.
While they have just one letter difference, how they operate isn’t exactly the same. This guide provides some insight into how to tell the difference between s corp and c corp, as well as the pros and cons of each.
Difference Between C Corp and S Corp
Taxes are the biggest difference between C and S corporations. Tax is paid on the income of C corporations, as well as on the income you receive as an owner or employee. There is no tax on the income of S corporations. You and other shareholders report the earnings of the corporation as personal income.
S Corp vs C Corp
When it comes to S Corporations and C Corporations, There are three main differentiators: formation, taxation, and ownership.
- Formation: The default type of corporation is a C Corporation. As soon as you file articles of incorporation in your state, you are designated a C Corp. Form 2553 must be filed if you want to become an S Corporation. You might also need to file other forms to stay an S Corporation.
- Taxation: Corporate income taxes are paid twice by C Corporations: the company pays corporate income taxes and the shareholders pay federal income taxes on dividends. S Corporations do not pay corporate taxes. In this case, shareholders report their business income and losses on their personal tax returns. The only taxes they owe are those on their personal tax return. Corporate taxes do not apply.
- Ownership: C Corps aren’t restricted when it comes to ownership. Anyone can own a business, and there can be as many owners as you want. The number of shareholders in S Corporations is limited to 100, and they must be citizens of the United States.
Formation Advantages of S Corp vs C Corp
A limited number of shareholders isn’t necessarily a bad thing, especially if you value their opinions. This increases their involvement and allows them more input. It is possible for employees to become shareholders.
The C Corporation structure is easier to set up than the S Corporation structure. You’ll need less paperwork and when you file your articles of incorporation, you’ll be given the default status of a C Corp.
Tax Advantages of S Corp vs C Corp
Tax benefits are one of the biggest benefits of S corporations. On the owner’s personal tax return, only income and loss from their business must be reported. On their personal tax returns, most S corporations can deduct up to 20% of their business income. You may be able to write off your business’ losses on your personal tax return if you have an S Corp.
In C Corporation as long as the donations don’t exceed 10% of your company’s income, you can deduct 100% of charitable contributions and donations on your corporate tax return. In addition, you can help employees by deducting certain benefits, such as health insurance.
S Corp vs C Corp Ownership Advantages
If you’re looking for limited ownership, an S Corp is for you. These companies are limited to 100 shareholders, all of who must be U.S. citizens. The types of shareholders are the same. An S Corp is the right choice if you want to avoid a ranking order.
The ownership of the C Corps is not restricted. A C Corp is preferred if you plan on selling your company in the future, or if you want to raise money from investors. Shareholders can be unlimited. A C Corp makes it much easier to sell stock to potential investors. These companies can be owned by other C Corps, S Corps, other corporations, or trusts.
Formation Disadvantages of S Corp vs C Corp
An S Corp requires more work than a C Corp. After you file your articles of incorporation, you’ll need to file Form 2553 to become an S corporation. Different states require different things when you incorporate as an S corporation.
C Corporations are formed by default when you file your articles of incorporation, but it’s not always the right move for every business. You might have unlimited growth potential, but not every company is looking to get acquired or get business funding. It’s a good move for bigger companies or those who want to grow. You might not need to file as a C corporation if you don’t have a large company.
Tax Disadvantages of S Corp vs C Corp
S Corp tax filings tend to be watched more closely by the IRS than C Corp filings. S Corporation taxes are scrutinized more closely even if you aren’t under double taxation. You could lose your S Corporation status if the IRS realizes you made a mistake.
The biggest problem for C Corps is double taxation. Revenue from your company is taxed, and then you are taxed again for your personal returns. This means you’re losing money twice on your revenue. Smaller businesses are particularly adversely affected because they don’t have enough wiggle room to be taxed twice. Paying corporate taxes cuts into your earnings.
Ownership Disadvantages of S Corp vs C Corp
S Corps are more closely scrutinized by the IRS, so breaking any rules could result in losing your S Corporation status. You must, for instance, stay within the 100 shareholder limit and all shareholders must be residents of the United States. In addition, S Corps can have only one type of stock, whereas C Corps can have multiple types. You could be hurt if you have high growth potential or plan to do international business.
There are no restrictions on ownership or stock classes for C Corps. You’ll still need to keep your business up-to-date by managing it correctly. You will need to issue stock to shareholders and hold board meetings if necessary. Depending on where you are located, you may need to pay fees to maintain your C Corp ownership status.
S Corporation vs C Corporation: Which Is Best for You?
S corporations are popular with small businesses, which usually fall within the legal limitations of an S corporation. Corporations of certain types find more advantages than a C corporation. While C corporations are the default company filing status, they’re not right for every business.
Many large corporations, those with a lot of start-up capital and big ambitions, or those planning to sell stock internationally do not qualify for an S corporation. For large companies, flexibility may be important, such as being able to have more than 100 shareholders, selling shares to investors who are not U.S. citizens or residents, and having shares owned by other entities.
To determine whether a C corp. or S corp. is the right entity for your business, it is important to carefully consider the above factors as they relate to your particular business situation.
FAQs:
The main difference lies in the way they are taxed. A C Corporation is subject to double taxation, meaning both the corporation and its shareholders are taxed on profits. An S Corporation, on the other hand, allows for pass-through taxation, where profits are only taxed at the individual shareholder level.
C Corporations offer limited liability protection to shareholders, meaning their personal assets are generally shielded from the company’s debts or liabilities. They also have the ability to raise capital through the sale of stocks and can potentially enjoy more flexibility in terms of ownership and management structure.
An S Corporation allows for pass-through taxation, which can result in potential tax savings for shareholders. It also provides limited liability protection and the opportunity for shareholders to receive distributions of profits without paying self-employment taxes on those distributions.
Yes, an S Corporation has certain ownership restrictions, such as limiting the number of shareholders to 100, requiring shareholders to be U.S. citizens or residents, and allowing only certain types of shareholders, such as individuals, estates, or certain trusts.
Yes, under certain eligibility criteria, a C Corporation can elect to become an S Corporation by filing Form 2553 with the IRS. This allows the corporation to take advantage of the pass-through taxation benefits and potentially reduce the overall tax burden for shareholders.
