Key Takeaways:
C corps have double taxation while S corps have pass-through taxation.
C corps can have unlimited owners, while S corps are limited to 100 shareholders.
C corps are the default entity you are assigned during registration.
Setting up a business structure is one of the most important foundations of jumpstarting your business growth. Some people opt for LLCs, but there are others who go for S Corporation or C Corporation. If you’re trying to choose between the two business structures, it’s important that you understand what each legal entity entails and its unique differences. This will not only save you time and money but also protect you from unnecessary headaches in the future.
Yes, at a glance, their only difference is one letter, but there’s more to S Corps and C Corps than that. They also have different modes of operation. In this guide, we’ll highlight the significant differences between the two entities as well as their similarities to help you make an informed decision.
S Corporations and C corporations: The Basics
C-corps are legal business entities that are owned by shareholders, who elect a board of directors. The board then chooses a management team to run the corporation. Most of the major companies that trade via the NASDAQ and the New York Stock Exchange (NYSE) are often C corps. You should, however, note that you can register even small privately-owned businesses as C corps. This is because they are part of the Internal Revenue Service’s internal revenue code under Subchapter C.
S corps, on the other hand, are sometimes referred to as small business corporations. They are business entities that companies the corporate-level status of C corps with the protection of LLC. They are part of the Internal Revenue Service’s internal revenue code under Subchapter S.
What Are the Similarities Between S Corporations and C Corporations?
Here’s an interesting fact: both business entities gain their names from the Internal Revenue Code parts that they are taxed under; Subchapter C for C corps and Subchapter S for S corps. Some of the qualities that both entities share include;
Limited liability protection: Since both entities are corporations, they have limited liability protection. This means that the shareholders, whether from a C corporation or an S corporation, aren’t responsible for the business liabilities and debts.
Structure: Both business entities have officers, directors, and shareholders. The shareholders are typically the corporation owners, but in reality, the corporation itself is in charge of the business. First, the shareholders elect a board of directors to direct and oversee the corporation’s affairs. They’re also in charge of decision-making but have no role in day-to-day operations. This is where the officers come in. The BOD elects them to handle the daily affairs.
Entity: Both S corps and C corps are separate legal entities. They are created through state filing.
Document Filing: You must file the formation documents of both S corps and C corps with the state. These documents, referred to as the Certificate of Incorporation or Articles of Incorporation, have the same structure regardless of the business entity you choose to be taxed under.
Corporate Formalities: According to the state corporation laws, there are no differences between both types of business entities in terms of compliance responsibilities. For starters, they have to follow the external and internal corporate obligations and formalities such as holding director & shareholder meetings, adopting bylaws, maintaining a registered office and registered agents, paying annual fees, filing annual reports, and issuing stock.
Top Differences Between S Corps and C Corps
There are 3 main differences between S corps and C corps:
Taxation
If you’re a small business owner deciding between C corporations and S corporations, your decision should boil down to how you’d like your entity to be treated when it comes to federal income tax. Most people choose S corps to save on tax because C corps typically get taxed twice. This means that even after the company pays corporate income tax, the shareholders are also required to declare their income and pay federal income taxes on their dividends. So, the business will pay the tax at a federal level, and the shareholders are also taxed on an individual level.
S corporations, on the other hand, are subject to pass-through taxation. They first file Form 1120S (informational federal return form) but don’t pay income tax on a corporate level. Instead, the business’s profits and losses are reported on the owners’ personal tax returns. So all due taxes are paid at an individual level.
S Corp vs. C Corp Tax Advantages in a nutshell:
If your business is an S corp, you can write off the corporation’s losses on your individual tax return. Most of the time, this type of entity allows you to deduct upto 20% of your business income in your individual tax returns.
On the other hand, C corps have double taxation, although this is capped at 21%. You are also allowed to deduct all your charitable donations and contributions as long as they aren’t more than 10% of your corporation’s income.
What Are the Main S Corp vs. C Corp Tax Disadvantages?
S corporations may not be subject to double taxation, but the IRS watches their tax filings closely. So, your S corp taxes will be more scrutinized, and if the IRS notices any mistake, they could cancel your entity’s status.
The biggest downfall for C corps is usually the double taxation element. This means that you’ll be losing money twice as your businesses returns will be taxed as well as any revenue that you earn. This is especially hard for small businesses that are still growing and barely have enough time and resources to file taxes twice. C corporations also don’t allow personal income tax returns write-offs.
Formation
When you’re registering your business, C corporations are usually the default corporation type. This means that when you’re filing Florida’s certificate of incorporation, you’ll automatically be designated a C Corp. If you’d, however, like to register your business as an S corporation, you should complete the relevant forms, especially Form 2553.
Typically, C corporations are easy to form, and there’s less paperwork to file. This is further enhanced by the fact that when you start filing the articles of incorporation, C Corp is the default status that you’re assigned.
Some people, however, prefer S corporations because incorporating them is more affordable and less burdensome compared to C corporations. This is especially true if you start your entity as an LLC and then switch it to an S corp for tax purposes.
What Are the Main S Corp vs. C Corp Formation Disadvantages?
S corp formation is complex compared to C corp formation as you have to file extra forms. Registering your business as a C corp, on the other hand, may be easy but may not necessarily be the best decision if you’re a small business that’s not looking to be acquired.
Ownership
If you register a business as an S corporation, you’ll be restricted to 100 shareholders. The owners also must be non-profits, estates, trusts, or individuals. C Corps, on the other hand, don’t have ownership restrictions, and any entity can invest in your business, including venture capital firms and mutual funds. In addition, you can have as many owners as you please and can issue stock certificates publicly.
Even though S corps have ownership restrictions, this is not necessarily a bad thing. This is especially true if you’d like your shareholder’s input in running the business. Due to the limited number of shareholders, it’s easy for them to become involved in your corporation’s daily operations. This is why most S corp shareholders are usually employees.
You should also note that S corporations are restricted to 1 one class of common stock while C corporations can issue various types of stock, including preferred shares, common shares, Class A shares, and Class B shares.
What Are the Main S Corp vs. C Corp Ownership Disadvantages?
Since S corps are under heavy scrutiny from the IRS, you need to adhere to the rules or risk losing your S Corp status. This means adhering to the 100 shareholder limit and issuing one class of stock. So, if your business has high growth potential or is planning to go international, registering your entity as an S corp could hurt your plans. S corps also can’t be owned by other similar entities, LLCs, trusts, or C Corps. So if you plan on getting acquired later on in our growth journey, this will impact your business sale. C corps, on the other hand, may lack ownership restrictions, but this significantly makes it difficult to manage the business.
S Corp vs. C Corp Which One Should You Go for?
The decision should be based on the individual needs of your business and future plans. For instance, if you have a big corporation, it’s easier to register as a C corp as you can get as many shareholders as you want. You will ever be subject to double taxation. S corp entities, on the other hand, are more suitable for small businesses that have no plans of being acquired in the future.
Want to learn more about C corps and S corps? Contact us today for further details.