Deciding to incorporate your business is a defining moment in your entrepreneurial career. For many small business owners, choosing how to incorporate is a matter of deciding between forming an S corporation vs. a C corporation.
On the fence regarding which kind of corporation your small business should be? You’re in luck. We’ll review the differences between S corp and C corp structures and help you make the best decision.
S Corp or C Corp? Key Differences
There are several differences in S Corp and C Corp entities. Here are a few.
Pass-through taxation: Income, deductions, losses and credits flow through to shareholders
Double taxation: Both the corporation and shareholders are taxed
Limited to 100 or fewer shareholders who must be U.S. citizens or residents
No restrictions on shareholder numbers or citizenship
Can’t be publicly traded
Can be publicly traded
Limited to 1 class of stock
No restrictions on stock classes
Must file IRS Form 2553 to qualify as a Subchapter S Corporation (S Corp)
Standard corporation type
An Overview of Corporate Structures
Other categories of business organizations exist beside C corp vs. S corp. Among these include sole proprietorships, corporate partnerships and limited liability companiess (LLCs). Many individual entrepreneurs start out as sole proprietors. Other times, businesses are categorized as corporate partnerships, meaning multiple partners share in the business’s liability.
Many business owners often wonder, though, how the following 3 compare: LLC vs. S corp vs. C corp.
An LLC is one of the most popular forms of business ownership in which the legal terms of a standard corporation and a partnership are blended. Although not technically considered a corporation, the owners still benefit from limited liability as they would with a formal corporate entity.
A corporation is any type of business whose legal persona is distinct, under the law, from that of its owners. Owners of a corporation are referred to as shareholders. They can be involved in the day-to-day operations of the company by sitting on an elected governing body, namely a board of directors.
A C corporation is considered the standard corporation. according to the Internal Revenue Service (IRS), while an S corporation is an offshoot. In both cases, owners pay personal income tax on their profits.
What Is an S Corp and a C Corp?
Understanding the difference between S corp and C corp companies begins by understanding that they’re both formal business enterprises. In other words, they are legal entities that are distinct from the individuals who own them.
Main Differences Between Business Entities
An S corp is a pass-through entity, meaning the company’s profits flow through the shareholders’ personal tax returns. As such, they’re taxed only at the personal rate, which can be lower than the corporate tax rate, depending on the state.
While few would disagree the differences between a C corp vs. LLC are minimal, an S corp features a streamlined tax-filing process that offers convenience and expediency compared with LLCs and C corps.
Additionally, when business owners weigh S corp vs. C corp tax advantages, the double-tax factor associated with C corps is usually the main consideration.
Also keep in mind that S corps must maintain fewer than 100 shareholders and one class of stock.
Here’s a more in-depth C corporation vs. S corporation comparison:
C corps are shareholder-owned businesses whose owners enjoy limited liability in a legal and financial sense.
One of the main differences between an S corp vs. C corp. is that a C corp inflicts a double tax on its owners. During tax season, it isn’t uncommon for business owners (i.e., shareholders) to be taxed on the dividends that they’re awarded at year-end. Likewise, the business itself is taxed on its gross revenues.
Most large companies in the U.S. are C corps for tax purposes. Although both small and large U.S. businesses alike are structured as C corporations or S corporations, only C corps are subjected to corporate income taxation.
Less common than its C corp counterpart, an S corp is closely held corporation. They are named after the segment of the U.S. Internal Revenue Code that outlines the rules for this corporate status.
Similarities and Differences Between S vs. C Corp Businesses
Perhaps the greatest similarity between S corps vs. C corps is that shareholders enjoy limited liability in both cases.
The key difference between C corp and S corp structures, however, is the owners of an S corp benefit from pass-through taxation.
When entrepreneurs decide to incorporate their business, they need to decide how they want their company to be taxed, whether as a C corporation or an S corporation. The pass-throughs associated with S corps mean the business isn’t taxed. Rather, only the owners themselves are taxed because the company’s income is reported on the owner’s tax returns.
This is essentially the opposite of the double tax that C corps face.
Creating C Corporations and S Corporations
If you’ve decided that you want to incorporate your small business, you may be wondering if there’s a difference between the process of incorporating a C corp and an S corp.
The only substantive difference is S corps are established when the owner files IRS Form 2553. In addition to a federal filing, some individual states may require you to file as an S corporation. Regardless of which type of corporation you’d like to form, the following steps are necessary in most states:
- Appointing a board of directors
- Filing articles of incorporation (i.e., “incorporating documents”)
- Issuing stock certificates to shareholders
- Drafting bylaws and resolutions
To receive their certificate of incorporation, all corporations must pay an administrative and filing fee ($250 or less).
Taxes: C Corp vs. S Corp
Learning how to file taxes as a small business owner can prove daunting. However, incorporating your business can simplify the process. Below, we’ve outlined the respective tax advantages and disadvantages as the main difference between S and C corporations.
Final Thoughts on Incorporation
As you weigh the S corp vs. C corp vs. LLC advantages, consider that an S corporation avoids the double taxation that C corporations are subject to.
Whereas C corporations are taxed at both the personal and the corporate level, S corps are pass-through entities that are only taxed at the personal level.
Ultimately, the decision to incorporate as an S corporation or C corporation is a context-specific decision that depends on several factors. While the S corp status is often desired by small business owners for its pass-through tax advantage, there are several stringent rules set out by the IRS that restrict one’s eligibility to structure a company as an S corp.
The bottom line is that business owners need to consider their long-term interests before they decide to incorporate. If you prefer the simplicity of a small, tight-knit business, an S corp might be your best option. However, those who aspire to raise significant outside capital and sell company stock should consider incorporating as a C corp.