Both S corps and C corps have their similarities and differences. The main differences between a C corp and an S corp are how they are formed, the ownership restrictions, and how they pay taxes. The following guide will show you the advantages and disadvantages of each structure and help you make a well-informed decision.
|C corp||C corps have limited liability protection, so personal assets are off limits in the event of business debts and lawsuits etc.||C corps experience double taxation. They are taxed at the corporate level and again on the individual level as shareholders must report income on their personal tax returns.||A board of directors and officers must be elected. They are responsible for managing day-to-day operations using the corporate bylaws as their guide.|
|S corp||S corps offer personal liability protection, ensuring that the personal assets of owners cannot be taken to pay off business debts and obligations.||S corps are pass-through entities. So all income is passed through to the owners to report on their personal tax returns. There is no corporate tax paid by the S corps.||A board of directors and officers must be elected. They are responsible for managing day-to-day operations using the corporate bylaws as their guide.|
|LLC||Provides personal liability protection so that members are only responsible for debts, losses etc based on the financial investment they’ve put into the company.||Liable for income and self-employment taxes. Considered “disregarded entities,” income taxes are passed-through to members.||Must file Articles of Organization, relevant tax returns, annual reports and renew licences and permits.|
What is a C corp?
A C Corp, also known as a C corporation, is a type of legal business entity owned by shareholders. The owners or shareholders then elect a Board of Directors, who, in turn, choose the officers to complete the management team. Some examples of C corporations are major corporations such as NASDAQ. However, corporations may also be small businesses.
A C corp is seen as a separate business entity by the Internal Revenue Service and pays taxes on its income.
Additionally, C corps are taxed on the personal level, so owners also pay personal income tax on profits or taxable income that they gain from dividends in the company. However, double taxation can be avoided by forming your company as a limited liability company or LLC or electing the S corporation status.
However, the latter business structures also come with their limitations. If you’re looking for limited liability protection for owners, then a C corporation offers it. Therefore, if the business goes into debt or is faced with a lawsuit, the owners are not held personally responsible, and none of their personal assets can be seized or used to pay off company debts.
However, a creditor can go pursue the business itself and the business’s assets; but none of the personal assets of the individual owners can be touched.
C corp benefits
- Tax benefits: In a C corporation, shareholders may be given a salary even if they are not involved in running the company. The salaries may then be claimed as business expenses, delivering a huge tax benefit in reducing corporate income tax.
- Perpetual existence: C corporations exist independently of any board member, owner, or shareholder. So if a shareholder or member passes away, the company itself will continue.
- Fringe benefits: When it comes to B2B relationships with customers, suppliers, vendors, and clients, C corporations, command more respect. This is because they’ve gone through the strict process of forming the business and registering it with the state and federal government.
- Limited liability: C corporation owners are considered separate legal entities by the Internal Revenue Service, which means that the company’s assets are distinct from the owners’ assets. Therefore, creditors cannot use business owners’ personal assets in the event of lawsuits, company debt, and business obligations.
C corporation drawbacks
- Complexity: Corporations come with very strict formal requirements for creating the business and have stringent ongoing compliance requirements. The operation and management structure is also quite formal compared to sole proprietorships and partnerships.
- Double taxation: The biggest drawback of the C corporation is the double taxation they are subject to. Double taxation simply means that the corporation is taxed at the corporate level, and the shareholders are then taxed again at the personal income level.
Read more about corporations.
What is an S corp?
An S corporation, also called an S Corp, is considered a separate legal entity by the Internal Revenue Service. It’s sometimes referred to as a small business corporation. It is a combination of the protection of an LLC and the corporate-level status of a C Corp. You can think of an S Corp as a hybrid between an LLC and a C Corp. Consequently, there are certain tax advantages to businesses that elect an S Corp status as an S corp is a tax status.
For one, an S corporation is not liable to pay federal income tax as its profits pass through to the business owners, who are liable for reporting them on their personal income tax returns. This is known as pass-through taxation. Therefore, S corporations do not pay double tax and are only taxed on the individual level. Additionally, S corps grant limited liability or personal liability to their owners.
S corp benefits
- Pass-through taxation: One of the major benefits of S corporations is pass-through taxation, also referred to as flow-through taxation. Pass-through taxation is a term used to describe the profits and losses of the corporation passing through to the individual’s tax returns. Therefore, corporations do not pay corporate taxes but individual taxes.
- Ease of conversion: If an S Corporation wants to change its structure to a C corporation, it can simply do so by contacting the Internal Revenue Service.
- Personal asset protection: Another huge benefit of an S corporation is the liability protection provided to owners. In the event of any lawsuits, malpractice claims, or business debt being incurred, the owner’s assets cannot be used to pay off creditors.
- Salary and dividend payments: S corporations may receive both the dividend and salary payments from the corporation, ultimately resulting in lower tax payments.
S corporation drawbacks
- Membership restrictions: S corporations are not allowed to have more than 100 shareholders compared to C corporations, which can have unlimited shareholders. If an S corporation exceeds 100 shareholders, the owners will need to change the structure to a C corporation.
- Allocation of profits and losses: Business entities like LLCs have flexibility when allocating profits and losses, whereas corporations must allocate profits and losses to shareholders based on the percentage of ownership.
- S Corp status: S corporation status is not simply granted without meeting certain requirements and criteria. So to be taxed as an S Corp and be considered an S Corp, you will need to be approved and meet the necessary criteria.
- Corporate formalities: S corporations, like C corporations, have stringent formation requirements compared to sole proprietorships, LLCs, and general partnerships.
At a glance: How is an S corp different from a C corp?
- S corps and C corps have similarities and differences. One of the major differences is how they are formed and taxed and the restrictions on ownership.
- C corporations must pay corporate tax rates on their corporate tax return, and there are no ownership limitations. However, when electing S Corp status, the structure is considered a pass-through entity responsible for reporting its income on the shareholders’ income taxes.
- However, with S corps, the ownership is limited to 100 shareholders.
- Ultimately, the decision will come with some implications in terms of your freedom to generate capital, how straightforwardly you can grow your company, and how you’ll pay taxes.
Should I start an S corp or a C corp?
To determine whether or not you need to remain with the default corporation structure, which is the C Corp entity, or whether you need to elect S corporation status, it all depends on the advantages and disadvantages that come along with both types of business entities. Therefore, you’ll need to consider quite a few factors, such as the number of shareholders you’d like to have in the corporation, the restrictions on ownership, the restrictions on classes of stock, the tax implications, and so on.
S corp vs. C corp taxes
There’s a difference between how S corps vs. C Corps are taxed. So let’s take a closer look at that below.
S corp taxes
- An S Corp is considered a pass-through entity for tax purposes, meaning that the owners or shareholders must report their share of the business’s losses and profits on their tax returns.
- Shareholders may report their share of profits and losses by filing Form 1120S.
- S corp owners are liable for paying taxes at the personal income tax rate.
- S corporations, along with other pass-through entities such as partnerships, sole proprietorships, and LLCs, may also be able to deduct up to 20% of qualified business income from their tax returns.
C corp taxes
- C corporations experience something called double taxation. Double taxation is when the corporation pays taxes on the business profits as the corporate income tax return or Form 1120 is filed.
- C corp owners are also liable for paying taxes on business profits on their personal or individual income tax returns. This is when the C Corp distributes these profits to owners as dividends.
- You can prevent double taxation by electing S Corp status.
- Alternatively, you can re-invest the profits into the company instead of paying them out as dividends. Some of the tax-deductible expenses include salaries, wages, and owners’ salaries.
S corp vs. C corp: Formal requirements
Although there are many similarities in how S Corps and C corps are formed, the differences begin with the formation process. Let’s take a closer look at it below:
Formal requirements for S corps
- S corps must file the Articles of Organization, create corporate bylaws, elect a Board of Directors, and appoint a registered agent.
- If you’d like to elect S Corp status for federal tax purposes, you must file IRS Form 2553.
- However, depending on your state, you may need to file additional paperwork to be treated as an S corp.
Formal requirements for C corps
- With a C corporation, you’ll need to file Articles of Incorporation, also referred to as Articles of Organization, and several other documents with the Secretary of State.
- In this case, your corporation is the standard or default C Corp structure.
However, you’ll still need to file the necessary paperwork and pay the relevant filing fees if you choose to structure your business as a C Corp or S corp. You are also responsible for remaining compliant by paying the relevant ongoing fees and submitting annual reports on time.
S corp vs. C corp: Management structure
- A Board of Directors manages S corporations and C corporations and their officers. However, C and S corporations are responsible for remaining in good standing with the state by ensuring they file the relevant paperwork, send in the necessary annual reports and pay their taxes.
S corp vs. C corp: Ownership structure
The ownership structure for S corps and C corps are very similar; however, they have slight differences. Let’s take a look at them below:
S corp ownership
- S corporations are only allowed to have a maximum of 100 shareholders.
- To be a shareholder in an S corporation, you must be an American resident, a U.S. citizen, or a natural person holding a U.S. passport.
- Entities like other corporations and trusts cannot own shares of stock in an S corporation.
- Additionally, each shareholder has equal voting rights since only one class of stock is allowed for distribution.
- It’s difficult to fund-raise as an S Corp instead of raising capital as a C corp.
C corp ownership
- Preferred stock is an option that’s available only to C corps. A C corp will be an ideal choice if you’re planning on selling your company.
- Another point to note is that a C Corp cannot own an S Corp, LLC, trust, or general partnership.
- Other corporations, including trusts or LLCs, can own C corporations.
- If you form the default corporation structure, which is the C corp, there are no limitations on ownership.
- You can have an unlimited number of shareholders.
- Additionally, you can also have various classes of shareholders.
There are differences between S corps vs. C Corps. However, there are advantages to each type of business structure as well. If you’re looking for options to expand and raise money, then a C Corp is your best bet. However, an S corporation is highly recommended if you’d like to save money on business taxes and be a small business owner. Before deciding which type of business to form, you should also consider other types of business entities and find out the advantages and drawbacks of each. Making the final decision to structure your business as a certain entity is quite a big decision with consequences and rewards for your business’s future. So take the time to consider all factors before making your final choice.
When it comes to who pays more taxes between an S Corp and a C corp, the answer is C corps pay more taxes. This is because S corporations are not liable for double taxation like C corporations are. So C corporations pay income at the corporate and individual levels, while S corporations only pay income at the personal level.
While an LLC is a low-maintenance legal entity, if you do not elect a specific tax structure, then your LLC will default to be taxed as a sole proprietorship. However, LLCs can also choose to be taxed as S corps and enjoy single taxation or choose to be taxed as C corps and become liable for double taxation.
One of the major reasons to choose to form an S Corporation is the limited liability protection it offers regardless of tax status. The personal assets of the owners or members are shielded from creditors, and this is a huge advantage when it comes to business debt and litigation.
There is no specific S corporation tax rate since S corporations are not liable for federal corporate income taxes. However, this doesn’t mean that they are not liable for tax at the state level. However, in an S corporation, the corporation’s shareholders split up the incomes and losses between each other and then report them on their tax returns.
Forming an S corporation comes with several advantages, including protection of assets, pass-through taxation, straightforward transfer of ownership, heightened credibility, and the benefit of single taxation.