It’s a major moment in your entrepreneurial career when you decide to incorporate your business. When most companies are just getting their start, they begin by default as a sole proprietorship—an arrangement in which the business and its owner are the same from the perspective of the taxman.
As your company grows and takes on new talent, purchases real estate and hires employees, there comes a time to consider restructuring your small business through incorporation. For many small business owners, choosing how to incorporate is a matter of deciding between “S Corp vs C Corp,” since these are two of the most popular corporate structures.
Are you stuck on the fence regarding which kind of corporation your small business should be? Well, you’re in luck. In this article, we’ll walk you through the difference between S and C Corp structures and provide you with everything you need to know to make this crucial decision.
Corporate Structures 101
There’s a lot more to incorporating your business than knowing the difference between a C Corp vs S Corp. In total, there are five broad categories of business organizations that each have their share of drawbacks and advantages:
- Sole Proprietorship
- Limited Liability Corporation (LLC)
As you might expect, both the S and C Corporation are a type of corporation that is dissimilar to partnerships, cooperatives, LLCs and sole proprietorships. To help you get the gist of their differences, we’ll touch on each of these business organizations below.
A sole proprietorship is often the de facto business type for many entrepreneurial endeavors that are just starting out. Sole proprietorships are businesses owned by only one person. Businesses of this kind are simple to establish and are inexpensive to maintain and operate. For this reason, they’re the go-to choice for many early entrepreneurs.
The downside, however, is the owner of a sole proprietorship assumes complete responsibility for the conduct of the business. That is, the business owner takes on unlimited liability for the finances and debts of the company.
A corporate partnership is a company that is owned by multiple partners that each share in the liability of the business. Partnerships, by definition, must be owned by more than one person, with all parties contributing to the business’s finances and, in turn, sharing in the profits.
There is a stark difference between general and limited partnerships in that general partnerships involve partners with unlimited liability. On the other hand, owners of limited partnerships are protected since lenders cannot claim the personal assets of the partners.
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 “stockholders” and are usually involved in the day-to-day operations of the company by sitting on an elected governing body called the “board of directors.”
Limited Liability Company (LLC)
A limited liability company (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.
Last, a cooperative business organization is one which is owned by a group of members in an effort to advance their mutual benefit. Although these entities are often incorporated, they sometimes are not. Credit unions and housing co-ops are examples of cooperative businesses that act in their member’s interests.
What Is an S and C Corp?
Understanding the difference between S Corp and C Corp companies begins by understanding that they are both formal corporations. In other words, they are legal entities that are distinct from the individuals who own them. However, no C Corporation vs S Corporation comparison can be done without first delineating their specific attributes.
C Corporations are shareholder-owned businesses whose owners enjoy limited liability in a legal and financial sense. In other words, the owners of C Corporations are “off the hook,” so to speak, when it comes to legal liability and taxation.
One of the main differences between an S Corp vs C Corp is that a C Corporation inflicts a “double tax” on its owners. During tax season, it is not 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 United States are C Corporations for tax purposes. Although both small and large American businesses alike are structured as C and S Corporations, only C Corporations are subjected to corporate income taxation. All C Corporations must pay a fee (usually $200 or less) to receive their Certificate of Incorporation.
Since it’s less common than its C Corp counterpart, we’re often asked: what is S Corporation? The long-form title of an S Corporation is a “subchapter S corporation,” named after the segment of the U.S. Internal Revenue Code that sets out the rules for governing S Corporations.
Perhaps the greatest similarity between S Corporation vs C Corporation is that shareholders enjoy limited liability in both cases. The key difference between C Corp and S Corp structures, however, is that the owners of an S Corporation benefit from “pass-through taxation.” Pass-through taxation is the opposite of the “double tax” that C Corporations are known for.
When an entrepreneur decides to incorporate their business, they need to decide how they want their company to be taxed. In the case of S Corporations, the business is not taxed—rather, only the owners themselves are taxed because the company’s income is reported on the owner’s tax returns.
Creating C and S Corporations
If you’ve decided that you want to incorporate your small business, you may be wondering if there is a difference between C Corp and S Corp in the process of incorporation. The only substantive difference in S-Corp vs C-Corp creation is that S Corps are formed when the owner(s) file IRS Form 2553 at the time of incorporation.
Regardless of which type of corporation you would 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
Taxes: C Corp vs S Corp
Learning how to file taxes as a small business owner can be daunting. However, incorporating your business can simplify the process. Below, we’ve outlined the respective tax advantages and disadvantages as the main difference between C and S corporation businesses.
When it comes to S Corp vs C Corp tax advantages, the main benefit of an S Corp is that it is a “pass-through entity” which avoids a double-tax. In other words, the company’s profits flow through the shareholders’ personal tax returns and, as such, are taxed at the personal rate. Depending on which state your business is incorporated in, this rate may be lower than the corporate tax rate.
Few would disagree that the difference between a C Corp vs LLC are minimal—however, an S Corp features a streamlined tax filing process that offers convenience and expediency compared to LLCs and C Corporations.
The double-tax factor is usually the main consideration when business owners weigh the S Corp vs C Corp tax advantages. In this case, C Corps are put at a disadvantage since they are taxed at both the personal and corporate tiers.
One caveat, however, is that S Corps must maintain fewer than 100 shareholders and one class of stock to be eligible for incorporation as an S Corp. If this rule is violated, the company is restructured as a C Corp.
C vs S Corporation: At A Glance
We’re often asked: why would you choose an S Corporation over a C Corporation? The answer, it seems, is simple. An S Corporation avoids the double-taxation effect that LLCs and C Corporations are subject to. Whereas the former is taxed at both the personal and the corporate level, S Corporations are pass-through entities that are only taxed at the personal level.
Ultimately, the decision to incorporate as an S Corp vs C Corp is a context-specific decision that depends on several key factors. While S Corporation 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 their 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 private stock should consider incorporating as a C Corp.