S-Corp vs. C-Corp: Definitions & Differences
S-corp and C-corp are used to describe different business structures and refer to the tax status of a company. Also known as S-corporations and C-corporations, these structures also determine liability protections for the owners of each organization. The following guide defines both C-corp and S-corp and compares the two tax designations.
What Is a Corporation?
Both C-corps and S-corps are legal business entities where the shareholders aren’t personally liable for the debts of the company. These corporations are set up by filing Articles of Incorporation in accordance with local laws. The owners are defined as shareholders. A shareholder’s responsibility is limited to their investment in the business. A company registered as a corporation will also usually have directors and officers who run the business.
When it comes to tax categories, C-corp is a default tax classification for corporations. However, companies that meet certain eligibility requirements can also choose S-corp taxation as an alternative.
Before we discuss the differences between S-corp and C-corp and analyze the pros and cons, it’s important to understand the broader definitions of these two structures. C-corp is the standard tax category for corporations. This is the most common corporate tax status and meets specific Internal Revenue Code requirements.
Within this structure, owners or shareholders are taxed separately from the corporation. The shareholders pay a personal income tax, and the corporation is taxed independently. But this also means that the owners are effectively paying a double tax because the government taxes the company’s earnings and the owners’ personal income.
S-corp refers to a corporate tax structure that offers an alternative to C-corp taxation. Rather than paying taxes on personal income along with a federal corporate income tax, the S-corp classification means that the corporation can pass income, losses, and deductions to shareholders to file on their personal tax return. S-corp is classified as Subchapter S of the IRS tax code. Businesses must meet certain criteria to become an S-corporation.
How Do C-Corporations Work?
The C-corp tax class is the most common type of tax status. In other words, most corporations are C-corporations. Once you have an Employer Identification Number or EIN, the IRS taxes both individual and corporate dividends. That’s why C-corp taxes are commonly referred to as a form of double taxation, as owners aren’t permitted to write off corporate losses to offset earnings when filing personal income statements.
How Do S-Corporations Work?
S-corp taxes don’t include a federal corporate income tax. If a corporation is registered as an S-corp, the company passes its income, credits, deductions, and losses to shareholders. The shareholders include income and losses on their personal tax returns and pay an income tax. With this system, shareholders are only taxed once.
S-Corp vs. C-Corp: What’s the Difference?
We’ve already touched on the key difference between a C-corp and S-corp business structure. But it’s beneficial to delve deeper into how these tax structures impact different companies.
For starters, there are several important differences during the business formation process.
How to become a C-corporation: After choosing an unregistered business name, you can set up a new entity by filing the Articles of Incorporation with the relevant Secretary of State. The business must appoint a board of directors, while those who purchase shares become owners/shareholders and pay personal income and corporate taxes.
How to become an S-corporation: Launching an S-corp also requires the business to have a legal name. Owners have to submit the Articles of Incorporation, obtain an EIN by filing IRS Form SS-4, and apply for all relevant permits. Additionally, any business that chooses to become an S-corporation or wants to switch from the default C-corp designation is required to file Form 2553 with the IRS. This form has to have all the details about the fiscal tax year and the signatures of all the shareholders.
There are certain criteria companies have to meet to become S-corporations, including:
- Have between one and 100 shareholders
- The shareholders cannot be nonresidents, partnerships, or other corporations.
- Have only one class of stock
Filing Tax Returns
C-corporations file quarterly returns, while S-corporations file annual returns.
It is also beneficial to note the differences in shareholder requirements between C-corps and S-corps. The number of shareholders is unlimited if your corporation is a C-corp. Meanwhile, the maximum number of shareholders at an S-corp is 100. It’s also important to be mindful of the IRS eligibility requirements for shareholders, one of which doesn’t permit nonresidents.
The table below offers a more comprehensive look at the differences between S-corporations and C-corporations:
|Default tax structure: formed through Articles of Incorporation||Articles of Incorporation + IRS Form 2553|
|Double taxation: personal income tax + corporate tax||Single taxation: personal income tax|
When are taxes filed?
|Every quarter||Every year|
Number of shareholders
|Unlimited||Limited to 100|
Types of shareholders
|Anyone who is eligible||Individuals + eligible estates, trusts, and organizations that are tax-exempt|
|Domestic and international||
IRS scrutiny level
S-Corp Pros and Cons
Before deciding which business structure is most suitable for your company, it’s important to weigh the pros and cons. Below are the main advantages and disadvantages of an S-corp tax status.
- The main advantage of S-corps is their adherence to the pass-through taxation system that allows shareholders to avoid double taxation and only pay a personal income tax.
- In some cases, the company’s losses can be passed on to owners.
- S-corporations only file tax returns once a year.
- Reduced taxable gains
- Limited liability for owners and employees
- S-corp shareholder limit of 100
- There are stringent requirements for shareholders, who must be US residents and cannot be partnerships.
- Only one class of stock allowed
- It’s more difficult to raise equity because S-corps tend to be less appealing to investors, such as venture capitalists.
- More intense scrutiny from the IRS
C-Corp Pros and Cons
- Limited liability for shareholders, employees, officers and directors
- No limit on number of shareholders
- Shareholders can be either domestic or international.
- Easier to raise equity than with S-corporations
- More than one class of stock allowed
- Lower tax rate
- Double taxation system which includes a corporate income tax and a personal income tax for shareholders.
- Gains and losses cannot be passed to shareholders, which means that they cannot write off losses on their personal tax returns.
- May be more time-consuming to manage due to the rigid structure of the corporation.
What Business Would Benefit From Being An S-Corporation?
The outcome of the showdown between S-corp vs. C-corp ultimately comes down to your individual needs. Some corporations are better suited for the former. Here are some scenarios when the advantages of the S-corporation status may outweigh the disadvantages:
- You do not plan to have more than 100 shareholders or any investors that don’t meet the eligibility criteria.
- You don’t plan to issue preferred stock to shareholders.
- All your shareholders are based in the US.
- You plan to distribute income to shareholders.
C-Corp vs. S-Corp Tax Advantages: When Is C-Corp the Best Option?
You may wish to consider sticking with the default C-corp tax structure if the following circumstances apply to your business:
- C-corp taxes would be lower for your business than S-corp taxes.
- You plan to launch an IPO.
- You are looking for investors who may not be eligible for S-corporation investments.
- You have more than 100 shareholders, or some of your shareholders are from overseas.
- You want to make shares freely transferable.
- You plan to offer shareholders access to preferred stock.
Exploring Other Options
C-corps and S-corps offer a range of benefits for businesses, but they are not the only options for companies. There are other types of corporations and additional structures to consider.
Other types of corporations include:
- Benefit corporations: These are also known as B-Corps and public benefit corporations or PBCs. The designation is held by for-profit companies that balance their responsibilities to shareholders with social and environmental performance. This is a state and not a federal designation, and it’s available in most states. Most B-corps are also C-corps, but they can apply to become S-corps.
- Nonprofits: These entities become corporations for reasons that are not linked to generating profits. Nonprofit corporations are eligible for federal and state tax benefits.
Alternative business structures to explore:
- Limited liability company or LLC: LLCs are often considered the middle ground between corporations and partnerships. LLCs can be taxed in the same way as C-corps or S-corps but are not governed by the same rules and regulations. LLCs are often easier to run for small business owners.
- Sole proprietorships: Sometimes known as sole traders, sole proprietorships are regarded as the simplest and most flexible option for small business owners. With a sole proprietorship, the owner is only taxed at a personal level. This structure does not have shareholders and doesn’t allow stocks to be sold.
- Partnerships: This structure involves an agreement between two or more people who are also taxed on a personal level. Business owners may also want to consider limited liability partnerships or limited partnerships.
LLC vs. C-corp vs. S-corp
When setting up a new business or exploring options for an existing one, it’s helpful to look at the different structures and how they impact companies. Here are some key takeaways from the S-corp vs. C-corp vs. LLC comparison:
Forming an LLC involves choosing a business name, assigning a registered agent, filing Articles of Organization, drawing up an operating agreement, and applying for an EIN, also known as a federal ID number. Once you’ve completed these processes, you’ll need to submit business licenses and permits and open a bank account. To form a C-corp, you’ll need to file the Articles of Incorporation. To become an S-corp, there is an additional IRS form to complete.
LLCs can opt for S-corp taxation, in which case the businesses avoid double taxation. C-corporation status is effectively a double tax, which combines a corporate and personal income tax.
Setting up and running an LLC is often simpler than managing C-corps and S-corps. This is why small business owners are often advised to consider an LLC or a sole proprietorship.
C-corporations can have unlimited shareholders both in the US and overseas. S-corporations are limited to 100 shareholders. Shareholders must be US citizens and must also satisfy strict eligibility criteria. LLCs have members rather than shareholders.
One major difference between an LLC and a corporation is that the former can be a pass-through business, while S-corporations are not. That means that all profits and losses are passed through to individual LLC owners, whereas S-corp profits are held by the corporation.
LLC vs. Sole Proprietorship
A sole proprietorship is a business with a single owner who takes sole responsibility for the running of the company. There are no shareholders, and there is no legal separation between the proprietor and the business.
Meanwhile, an LLC is a legal business entity that can be created by a single person or a group of people. The LLC structure combines elements of corporations and partnerships, and it provides a lot of flexibility for business owners.
Here are some of the key differences between a sole proprietorship and an LLC:
- Formation: To form an LLC, you must file Articles of Organization, obtain the relevant licenses, and register your business name. To form a sole proprietorship, you simply need to obtain the relevant permits and register your name.
- Management: Multiple people can make decisions within an LLC. On the other hand, a single owner is responsible for making decisions with a sole proprietorship.
- Taxes: Both entities have a pass-through tax structure. However, an LLC can opt for corporate tax status.
- Liabilities: A sole proprietor is liable for business debts, while those who own an LLC are not.
The Best Option
There is no one-size-fits-all when it comes to selecting the appropriate business structure. That’s why it’s critical to take the time to research different options and compare the pros and cons of S-corps and C-corps.
Whether you are new to the corporate world or your objectives have changed, identifying the right avenue when registering your business will help you save money on taxes and provide you with the necessary liability protection.
Unlike C-corporations, S-corps can have a maximum of 100 shareholders. It is also important to note that there are stringent eligibility criteria for S-corp shareholders. For example, shareholders must be US residents. On the other hand, C-corporations can have an unlimited number of shareholders, including individuals from overseas.
An LLC can be an S-corporation. An S-corp is suitable for businesses that wish to avoid double taxation and give out corporate dividends to shareholders. If an LLC chooses a C-corp designation, it won’t have restrictions on the number of shareholders but will be subject to corporate and personal income taxes.
If an LLC is taxed as a sole proprietorship, it pays higher taxes than S-corps. Sole proprietorship owners have to pay a self-employment tax on their profits. With an S-corporations, owners can reconfigure the amount that is subject to the self-employment tax.
It is possible for business owners to have an LLC taxed as an S-corp. There are advantages and disadvantages of making an LLC an S-corporation. The pros include saving money on taxes through paying yourself a salary and distributing dividends to shareholders. Tax rates on dividends are lower than salaries. The downsides to consider are a salary cap, which means that you can only pay yourself a set amount of money and limitations on shareholders and stock class.
In the S-corp vs. C-corp showdown, the former emerges as the better option if you don’t have more than 100 shareholders and want the pass-through taxation system. With S-corp, income is only taxed at the individual level. With C-corporation, there is a double tax system, which combines personal income tax and corporate tax.
The major benefit of S-corp status is not having to pay federal corporate taxes. Many people can save money by opting for S-corp tax status, particularly when the business is in its early stages. The S-corp tax status is referred to as pass-through taxation, enabling individuals to write off losses on a personal tax return. It is possible to turn an LLC into an S-corp. If you are thinking of taking this step, it’s a good idea to consult tax experts and explore how modifying your tax status would impact your tax returns.
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