Determining how you would like your company to be established and structured is crucial to your business’ success. There are a few options to consider when choosing the correct business structure. One popular legal entity is corporations, which covers C corporations (C corp) and S corporations (S corp) as two of its common types.
While C and S corps share some similarities, they differ in taxation, shareholder restrictions, ownership, stocks, and scale of operations. IRS regulations state that the C corporation is the default business entity. Form 2553, along with other forms, must be completed if you wish to form and maintain your status as an S corporation.
C corporations are taxed individually as separate entities. Form 1120, a corporate tax return, must be filed, and corporate taxes must be settled. The filing of taxes under C corps happens every quarter.
When earnings are paid to the owner(s), they are required to pay a personal income tax, resulting in double taxation. On dividends, corporate income tax is paid first at the company level, then at the individual level.
Double taxation can result in a significant loss in profit and it creates an overall tax of around 58% of your income when it's all said and done. This number could be a touch higher or lower depending on the tax bracket you are in.
S corporations have a tax structure called “pass-through” and follow an annual filing of taxes. They submit Form 1120S, a federal information return, however they pay no income tax at the corporation level. Instead, the company's revenues and losses are “passed through” to the owners and recorded on their personal tax returns.
Moreover, when stockholders file a personal tax return, they record business income and losses. As a result, the only taxes they have to pay are those on their tax returns, and corporate tax does not apply.
Ownership Flexibility and Restrictions
When it comes to ownership, C Corps have no constraints or limitations. Any other legal body, foreign or domestic, can take ownership. There are also no restrictions regarding the number of owners as you can have as many shareholders as you want.
S corporations can have up to 100 stockholders, all of whom must be US natural-born citizens or residents. C corporations, other S companies, LLCs, partnerships trusts, and other artificial organizations cannot own S corporations.
Multiple stock classes and profit-sharing systems are possible in C corporations. Due to this, the voting rights of shareholders may be distributed to adopt alternative profit-sharing strategies.
Only one stock class is allowed for distribution in S corporations allowing each shareholder to have equal voting rights.
C Corp and S Corp Comparison Table
|Formation||Standard or default business entity||Form 2553 must be submitted|
|Taxes||Gets taxed twice (corporate and personal tax)
Taxes filed quarterly
|“Pass-through” taxation (personal tax)
Taxes filed annually
|Shareholders||Unlimited number from any entity and citizenship||Maximum of 100 US natural-born individuals|
|Classes of Stock||Multiple||One class|
C Corp Advantages
- If your charity donations and contributions do not exceed 10% of your company's income, you can deduct them completely (100%) on your business tax return. You may also assist your employees by deducting certain perks, such as health insurance.
- The alternative minimum tax was repealed as part of the 2017 Tax Cuts and Jobs Act, which reduced the corporation tax rate to a flat 21%.
- It has an unlimited number of stockholders, and shares can be owned by anybody, including business organizations and Non-US residents. Therefore, it has a better chance of obtaining equity capital.
- It can issue many classes of stock, including shares with dividend and distribution preferences, so it's significantly easier to offer shares to potential investors through a C Corp. (Higher growth potential)
- It offers limited liability in the case of lawsuits against the company.
S Corp Advantages
- S corporations are exempted from corporate income taxes. As a result, any income distributed to shareholders is exclusively taxed from personal income.
- On their individual tax returns, the majority of S corporations can pay up to 20% of their corporate revenue. You can deduct your business losses on your personal tax return if you have an S Corp.
- Since this corporation is restricted to only one class of stock, a ranking order can be avoided.
- Offers limited liability
- Annual tax filing requirement
C Corp Disadvantages
- The primary drawback is the double taxation in which it pays tax on its gains while its owners settle tax on dividends, leading to the earnings of the company being deducted twice.
- There are no personal write-offs, which means shareholders cannot deduct business losses from their personal income tax returns.
- More expensive than starting an LLC or Partnership.
- There is a lot to learn when first forming a C corp. (More rules and regulations to follow)
- Quarterly tax filing requirement
S Corp Disadvantages
- S Corporation tax filings are scrutinized by the IRS more than C Corporation tax filings.
- Very strict ownership and shareholder requirements should be met. Tight compliance is a must since S Corps are monitored more closely by the IRS. Breaching any restrictions might result in the S Corp status being revoked.
- With only one class of stock, a firm with hopes of significant growth potential or plans to undertake international operations may suffer.
- Limited to 75 shareholders.
C Corp and S Corp Similarities
The qualities shared by the two corporations include their structure, filing of Articles of Incorporation document, adherence to corporate compliance and duties, and implementation of limited liability protection.
Both S companies and C corporations offer their shareholders limited liability protection, which relieves them from the company debt's responsibilities and other financial duties. They are both distinct legal entities that must file Articles of Incorporation with the state. Both are privately held and have a structure comprising a board of directors and officers.
A corporation's board of directors monitors significant decisions and defines the corporation's overall strategy. The daily operations are overseen by the executive officers, who are appointed by the Board of Directors. Both corporations must file official documents, hold annual meetings, set bylaws, and pay yearly fees.
Why choose a C corporation?
One might select a C corporation because of various reasons. These include limited liability protection and an unlimited number of shareholders that are not constrained by many limitations and requirements.
Furthermore, C corps offer a simple exchange of ownership, allow easy capital raising through stock selling, and pose a low IRS audit risk. In terms of tax, business costs may be tax-deductible, and a C corporation can provide self-employment tax benefits.
Why choose an S corporation?
Classifying a company as an S corporation can bear multiple benefits, especially when it comes to tax. S corps do not have to pay federal corporate taxes. Instead, the profits of the company are distributed to the owners. On dividends and distributions, owners do not pay self-employment tax, resulting in a lower overall tax cost for the owner.
Moreover, S corporations are legally distinct from their owners. This implies that in the event of a dispute or a lawsuit, only the business assets are at risk, not the owner's personal assets.
S corporations save a business owner tons of money in taxes at the end of the year and it can be easier to run if you are acting as the sole business owner due to less tax filings per year, and less rules and regulations to learn when initially getting started. However, there is stricter scrutiny from the IRS when it comes to S corps.
C corporations are ideal for larger scale businesses with multiple owners that are looking for unlimited growth potential as well as raise a significant amount of money for the company. In addition, C corps allow you to provide health benefits to your employee's which qualifies as a tax write-off at the end of the year.
Choosing to form your business into a C corp or an S Corp will likely come down to the scale of the operation you are trying to run. If you are thinking large scale, choosing a C corp is likely right for you due to the growth potential and tax write-offs it offers. If you are thinking smaller scale, choosing an S corp is likely going to be the best option for you, due to less taxes, and a much lesser learning curve when getting started.