What Is the Difference Between an S Corp and a C Corp?

How are an S Corp and a C Corp different?

According to IRS regulations, the default corporate structure is the C corporation. A business might choose to enjoy certain tax benefits by forming a S corporation, which is a special tax status with the Internal Revenue Service.

Both organizational forms are named after sections of the IRS Code that govern their taxation. When founding a business, you have the option to pick S corp status by filing Form 2553 with the Internal Revenue Service and meeting all of the S corporation criteria. S corporations are taxed under Subchapter S, whereas C corporations are taxed under Subchapter C.

Some characteristics that both C and S Corps have are as follows:

• Limited liability: In most cases, shareholders (owners) of a corporation are not personally liable for the debts or obligations of the company because of the limited liability protection that corporations provide. That remains the case regardless of its treatment as a C or S business for tax purposes.
• Unique legal entities: When a business files its paperwork with the state, it forms a unique legal entity known as a corporation.
• Records filing: The state must receive the formation records. The Articles of Incorporation, also known as the Certificate of Incorporation, remain unchanged whether your business is structured as a C or S company for tax purposes.
• Structure: There are owners, directors, and leaders in both S and C corps. Even if shareholders own a piece of the company, the real owner of the company is the corporation itself. To serve on the board of directors, shareholders vote. Although it is not on the hook for the daily operations of the organization, the board does monitor and control its affairs and decision-making. The board chooses the executives to run day-to-day operations.
• Business protocol: C and S corporations are both subject to the same obligations under state corporate legislation. Bylaws, stock issuance, director and shareholder meetings, registered agent and office maintenance, annual report filing, and fee payment are all examples of internal and external corporate formalities and requirements that all corporations must adhere to.

The Distinctions Between S Corporations and C Corporations

1. Taxation

When deciding between a S corporation and a C corporation, the primary consideration for most entrepreneurs is the tax treatment they would like the company to get from the federal government.

C corporations: These businesses are subject to separate taxes. They are required to pay taxes on a corporate level and submit a Form 1120 tax return. In addition, if company owners receive dividends—which are regarded as personal taxable income—they may be subjected to double taxation. First, the company level is responsible for paying the corporate income tax, and then once again, the personal level is responsible for paying the dividends.

S corps: These entities are subject to pass-through taxation. Although they are required to file a federal return (1120S form) for informational purposes, corporations are exempt from paying income tax. Instead, the earnings and losses of the firm are “passed-through” to the company, and they are recorded on the personal tax returns of the owners. Each owner is responsible for paying their own personal tax.

Personal income taxes: For both C and S businesses, personal income tax is owed on dividends and salaries that are taken out of the business.

2. Ownership of corporations

There is no difference between S corps and C corps according to state corporate regulations, as we have noted. To be considered a S corp, a company must adhere to certain shareholder requirements set down by the Internal Revenue Code.

S corporations can have a max of one hundred stockholders, all of whom must be citizens or permanent residents of the United States. There are no limitations on who can hold a C company.

Ownership: S corps may not be held by partnerships, LLCs, C corps, other S corps (with a few exceptions), or many trusts.

Company stock: S corps are limited to having a single class of stock (not including voting rights), whereas C corps are allowed to have numerous classes.

The benefits of a S corp

• One level of taxation: A single tax rate applies to S corporations, which is a major perk compared to C corporations. Accordingly, shareholders are subject exclusively to personal income taxes on any distributions of funds.
• 20% deduction for “qualified business income”: The Tax Cuts and Jobs Act of 2017 let certain S corp owners subtract up to twenty percent of their net “qualified business income.”
• Pass-through of losses: Under current tax rules, shareholders of a S corp may capitalize on the company’s losses to reduce their taxable income.

Disadvantages of a S corp

• A restricted amount of shareholders: A S corporation is not allowed to have more than one hundred shareholders, which eliminates the possibility of the corporation becoming public and restricts its capacity to acquire cash from new investors.
• Additional limits on shareholders: Except in some cases, shareholders must be persons who are residents or citizens of the United States. This further complicates the process of obtaining equity funding for a S corp, as private equity and venture capital funds are typically not considered acceptable stockholders.
• Preferred stock is not allowed: For a company to be a S corp, it can’t have different types of shares. Some owners want to be given easier access to payouts or other benefits. A S corporation is unable to provide that.
• Transfer constraints: Most S corporations will make it hard for owners to sell or give away their shares. That way, they won’t have to worry that the IRS would revoke their S corp registration since they had an invalid shareholder. Because of this, selling shares in a S corp becomes more of a challenge for the stockholders.

The benefits of a C corporation

1. Unrestricted shareholder number

A company that is subject to taxes under Subchapter C is not restricted in the number of stakeholders it can have.

2. Unrestricted ownership

Businesses and individuals outside the United States are welcome to own shares.

3. Classes are not limited

C corporations have the authority to provide many types of stock, including preferred stock, to their shareholders.

4. Reduced maximum tax rate

In addition to doing away with the alternative minimum tax, the 2017 tax reform bill slashed the corporation tax rate to a flat 21%. Although there has been a minor reduction in the rates of personal income tax, this rate is still lower than the highest possible rate of personal taxation, which is now 37%.

5. Additional avenues for obtaining funding

A C corp has an easier time getting equity funding since the tax code’s Subchapter C does not have the same ownership limits as Subchapter S.

Cons of a C corp

Double taxation

The C corporation’s primary drawback is that its profits are subject to double taxation because both the corporation and its shareholders are required to pay taxes on dividends.

When would it be more beneficial to form a S corporation than a regular C corporation?

When it comes to determining whether or not a small company owner should pick a S corporation versus a C corporation, there is no answer that is universally applicable. Every circumstance is different. When at least one of the following is true, though, the benefits could be greater than the drawbacks:

• You do not intend to sell shares to more than one hundred individuals or any other type of investor that is not authorized under Subchapter S, and you are not planning an initial public offering.
• Shareholders will receive income distributions from the company.
• Preferred stock is not going to be issued.
• After factoring in their individual tax rates, deductions, and exemptions, shareholders will have a lesser tax burden when employing a pass-through corporation compared to a separately taxable entity.

You can save money on your personal income taxes by claiming your losses as a deduction instead of paying income taxes.

When might a C corporation’s benefits exceed its drawbacks?

While there is no universally correct response to this issue, consider the following scenarios in which a C corp could be the best choice:

• The tax burden will be less under Subchapter C than Subchapter S.
• There will be no distributions to stockholders.
• You want to do an initial public offering (IPO) or seek investors, both of which are outside the scope of a S corporation.
• You would like the ability to freely transfer shares.
• You are considering issuing preferred stock.

Steps to Form a C Corporation (C Corp)

You can’t “become” or “create” a C or S corporation, actually. You incorporate—period. And to accomplish so, you must pay the filing fees and submit a document to the state that is often known as Articles of Incorporation (also called a Certificate of Incorporation).

You need to select a name for your corporation and confirm its availability before proceeding. Additionally, you must choose a registered agent. An organization’s Articles of Incorporation must contain the name of the company as well as its registered agent.

Additional obligations will arise after you have finished the incorporation procedure. The issuance of stock to owners, the adoption of bylaws, and the first meeting of shareholders and directors are all part of this process. Unless you meet the requirements and make the election to be taxed under Subchapter S, your corporation will be subject to taxation under Subchapter C.

Steps to Form an S Corporation

In order for your corporation to be taxed under Subchapter S, after you have filed your Articles of Incorporation with the state, you must submit Form 2553 to the IRS. The instructions provided by the IRS are not always easy to understand, but it is necessary to complete and submit Form 2553 in order for your election to be considered effective for the current tax year.

For taxpayers using the calendar year, this implies it must occur no later than March 15th, or no later than the 16th day of the third month.

At any point in the previous fiscal year. Nevertheless, for a tax year that is shorter than 2½ months, an election that is made no later than two months and fifteen days after the start of the year is considered on time for that year.

Your election will be effective for the following tax year if you make it after the 15th of the third month but before the end of the current one (unless you can prove that there was a valid reason for your inability to file on time).

After you incorporate your firm, you should know that several states additionally need you to submit a S corporation election at the state level.

What if you wish to change the tax treatment of your company?

As soon as you decided to incorporate your company, you were faced with the decision of whether your firm would be taxed as a C corporation or a S corporation.

What if you change your mind? This may occur, for instance, if your company’s objectives have evolved. Imagine you’ve changed your mind and are now keen on an IPO. On the other hand, tax regulations may have evolved to the point that your company is now better suited taxed in a different way.

In the wake of the passage of the Tax Cuts and Jobs Act in 2017, many small companies were reconsidering whether to switch from S company to C corporation tax classification, or vice versa. As previously mentioned, this law brought about several changes, one of which was a reduction in the corporate tax rate, which benefited C Corps. Another change was the provision of a special twenty percent deduction for pass-through companies, which benefited S corps that were eligible for it. (The new, lower tax rate was only one of numerous reforms.)

Government tax regulations are complex. When it comes to the manner in which your corporation ought to be taxed, both at the time of formation and on an ongoing basis, speaking with tax specialists can help you choose the best option for your business.

Should your small company form a C corp or a S corp?

From taxation to funding to expansion plans, your company’s legal structure affects numerous facets. To choose the solution that works best for your specific company needs and objectives, it could be helpful to weigh the pros and cons of the choices that are available.