When it comes to deciding how you want your company to be set up, you have a few options to consider. Some people will form an S corporation and others a C corporation. So, what are the benefits of an S Corp vs C Corp? Under IRS regulations, the C corporation is the standard (or default) corporation. An S corporation is a business that has chosen a special tax status with the IRS, benefiting from certain tax benefits. To elect S corporation status when forming a corporation, Form 2553 must be filed with the IRS and all S corporation guidelines met. Named after sections of the Internal Revenue Code under which they are taxed, Subchapter C applies to C corporations, while Subchapter S applies to S corporations. To help you decide what is best for your company, we’ll cover the main similarities, differences, advantages, and disadvantages of both S corporations and C corporations to help you decide what is best for your business.
S Corp vs C Corp: Similarities
Limited liability protection: Because corporations have limited liability protection, shareholders (owners) are usually not personally liable for the debts and liabilities of the company. This is true whether the company is taxed as a C or S corporation.
Separate Legal Entities: Corporations (C corps and S corps) are separate legal entities from the owners. As a separate legal entity, only the assets of the corporation are subject to corporate debts. Although there are some exceptions, a shareholder is not personally liable for corporate debts, and the assets of the shareholder are protected from business creditors.
Filing Documents: The state requires that formation documents be filed. Whether you choose to be taxed as an S corporation or a C corporation, these documents, known as Articles of Incorporation or Certificates of Incorporation, are the same.
Structure: Shareholders, directors, and officers are all present in S and C corporations. Although the shareholders of an S-corporation or C-corporation own the business, they don’t make most of the decisions. Management and policy issues are left to the company’s shareholder-elected board of directors. The board of directors is in charge of overseeing and directing the corporation’s affairs and decision-making, but not of day-to-day operations. The officers who will manage the day-to-day operations are chosen by the board.
Corporate Obligations: When it comes to compliance responsibilities, state corporation laws make no distinction between C corporations and S corporations. Corporate formalities and obligations, such as adopting bylaws, issuing stock, holding shareholder and director meetings, maintaining a registered agent and registered office, filing annual reports, and paying annual fees, are all required of all corporations.
S Corp vs C Corp: Differences
Taxation: C corporations are taxed separately, meaning they have to file a corporate tax return (Form 1120) and pay corporate taxes. If corporate income is distributed to business owners as dividends, which are considered personal taxable income, they may face double taxation. On dividends, corporate income tax is paid first at the corporate level, then at the individual level.
S corporations are taxed as pass-through entities. They file a federal return for information (Form 1120S), but there is no income tax paid at the corporate level. Instead, the business’s profits and losses are “passed-through” to the owners and reported on their personal tax returns. The owners pay any taxes that are due on an individual basis.
Corporate ownership: As previously stated, state corporation laws do not distinguish between S and C corporations. However, for the corporation to qualify as an S corporation, the Internal Revenue Code places several restrictions on who can be shareholders. Additionally, S corporations are limited to 100 shareholders all of whom must be US citizens or residents. The ownership of C corporations is unrestricted.
S Corp vs C Corp: Advantages and Disadvantages
S Corporation Advantages
Single-layer Taxation: The main advantage of an S corporation over a C corporation is that an S corporation does not pay corporate income tax. As a result, any income distributed to shareholders is only taxed at the individual level.
20% Business Income Deduction: The Tax Cuts and Jobs Act of 2017 allow shareholders of S corporations to deduct up to 20% of their net “qualified business income.”
Pass-through Taxation: An S corporation’s losses are passed on to its shareholders, who can use them to offset income (subject to restrictions of the tax law).
S Corporation Disadvantages
Limits and Restrictions on Shareholders: An S corporation can only have 100 shareholders, preventing it from going public and restricting its ability to raise funds from new investors. Individuals who are not citizens or residents of the United States are cannot be shareholders (with a few exceptions). This makes it more difficult for an S corporation to raise capital, especially because venture capital and private equity funds are typically ineligible shareholders.
Share Transfer Limitations: Most S corps will restrict their shareholders’ ability to sell or transfer their shares. That’s to make sure they don’t end up with an ineligible shareholder which will cause the IRS to terminate its S corp status. This makes it harder for the shareholders of an S corp to exit the corporation.
Ownership Restrictions: For companies that are hoping to get acquired at some point, S corp restrictions on the ability to be owned by other companies could hurt the sale of your business. This is because S Corps can’t be owned by other S Corps, C Corps, LLCs, or trusts.
C Corporation Advantages
Minimal Shareholder Restrictions: A corporation taxed under Subchapter C can have an unlimited number of shareholders. Also, anyone can own shares, including business entities and non-U.S. citizens.
Lower Minimum Tax Rate: The alternative minimum tax was repealed as part of the 2017 tax reform act, which reduced the corporate tax rate to a flat 21%. Despite the fact that personal income tax rates have been slightly reduced, this rate is still lower than the highest personal tax rate (which is currently 37 percent ).
More Capital Raising Flexibility: Because Subchapter C of the tax code does not impose the same ownership restrictions as Subchapter S, a C corporation can obtain equity financing more easily.
C Corporation Disadvantages
Double Taxation: The main disadvantage of a C corporation is that it pays tax on its earnings while its shareholders pay tax on dividends, resulting in double taxation of the corporation’s earnings.
So who wins the battle between S Corp vs C Corp? The argument for S Corp vs C Corp is not one size fits all. When making this decision for your business it is not always straightforward because it is dependent on the circumstances. However, you might want to consider an S corporation If these circumstances apply to you:
- You don’t intend to go public and won’t be selling shares to more than 100 people or investors ineligible under Subchapter S.
- Shareholders will receive income distributions from the corporation.
- You have no intention of issuing preferred stock.
- The shareholders’ tax liability will be lower if they use a pass-through entity rather than a separately taxed entity, taking into account their personal income tax rate, deductions, and exemptions.
- You will have losses that you can deduct from your personal income taxes to offset your income, resulting in tax savings.
Alternatively, the pros of C Corporation might outweigh the cons if:
- Subchapter C taxation will result in lower taxes than Subchapter S taxation.
- There will be no distributions to shareholders.
- You want to do an IPO or look for investors, which isn’t possible with an S corporation.
- You want to be able to freely transfer your shares.
- You want to make a preferred stock offering.
The C Corp status allows for large-scale growth and the ability to sell the company in the future. On the other hand, S Corp shareholder restrictions may be advantageous for businesses that want to remain small and closely held. Because the differences and respective benefits are unique to each entity make sure to carefully weigh the options when deciding what is best for your business.