When you start to develop how you want your business to be set up, you have a few different options to choose from. Some will go with an LLC, while others will look into an S Corporation or C Corporation.
While they only have one letter difference, how they operate aren’t exactly the same. Here’s how to tell the difference, along with the pros and cons of some major parts.
Difference Between C Corp vs S Corp
The biggest difference between C and S corporations is taxes. C corporations pay tax on their income, plus you pay tax on whatever income you receive as an owner or employee. An S corporation doesn’t pay tax. Instead, you and the other owners report the company revenue as personal income.
S Corp vs C Corp
There are three main differentiators when it comes to S Corporations and C Corporations: formation, taxation, and ownership.
- Formation — C Corporations are considered the default type of corporation. When you file articles of incorporation in your state, you’re designated a C Corp. If you want to be an S Corporation, you’ll need to file Form 2553. There might be other forms to complete to stay an S Corp as well.
- Taxation — C Corporations get taxed twice: the company pays corporate income tax and shareholders pay federal income taxes through dividends. S Corporations have pass-through taxation. This is when shareholders report business income and losses on a personal tax return. So the only taxes they face are the ones on their personal tax return. There’s no corporate tax.
- Ownership — C Corps don’t have restrictions when it comes to ownership. Anyone can be an owner, and there can be as many owners as you’d like. S Corps are limited to 100 shareholders who must be U.S. citizens.
S Corp vs C Corp Formation Advantages
S Corp Formation
The limited number of shareholders isn’t necessarily a bad thing, especially if you value the opinions of your shareholders. It makes them more involved in everyday operations and gives them a say. Employees can be shareholders.
C Corp Formation
C Corporations are easier to form compared to an S Corp. There’s less paperwork and when you file your articles of incorporation, the default status you’re given is a C Corp.
S Corp vs C Corp Tax Advantages
S Corp Taxes
Taxes are one of S Corporations’ biggest benefit. Owners only need to report business income and loss on personal income tax returns. Most S Corps can deduct up to 20% of their business income on their personal tax returns. If you have an S Corp, you have the opportunity to write off your business’s losses on your personal tax return.
C Corp Taxes
You can deduct 100% of your charitable contributions and donations on your corporate tax return, as long as the donations don’t exceed 10% of your company’s income. You can also help employees by deducting certain benefits, like health insurance, for your employees. While double taxation is a downfall, the 2017 Tax Cuts and Jobs Act capped C Corp taxes at 21%.
S Corp vs C Corp Ownership Advantages
S Corp Ownership
If you’re looking for limited ownership, you’ll fare better with an S Corp. These setups are limited to 100 shareholders who are required to be U.S. citizens. There’s no difference in the types of shareholders that can hold stock. If you want to avoid a ranking order, then an S Corp will work for you.
C Corp Ownership
C Corps don’t have any restrictions on ownership. If you’re planning on selling your company in the future — or looking for funding through investors — a C Corp is preferred. You can have an unlimited number of shareholders. So if you’re selling stock to potential investors, it’s much easier with a C Corp. These companies can be owned by other C Corps, S Corps, other corporations, and trusts.
S Corp vs C Corp Formation Disadvantages
S Corp Formation
Forming an S Corp is more work compared to a C Corp. When you file your articles of incorporation, you’ll need to file additional paperwork, including Form 2553, to become an S Corp. Some states have different requirements when you incorporate as an S Corporation.
C Corp Formation
Even though forming a C Corp happens by default when you file your articles of incorporation, it’s not necessarily the right move for every company. You might have unlimited growth opportunities, but not every company is looking to get acquired or get funding. It’s a good move for bigger companies or those looking to become bigger companies. If you don’t have a big company (or don’t want one), you might not need to file as a C Corporation.
S Corp vs C Corp Tax Disadvantages
S Corp Taxes
The IRS tends to watch S Corp tax filings more than C Corps. Even though you’re not subjected to double taxation, S Corp taxes are more heavily scrutinized. If the IRS discovers a mistake, your S Corp status could be canceled.
C Corp Taxes
Double taxation is the biggest downfall for C Corps. Your company’s revenue is taxed, and then you’re taxed again for personal returns. It means you’re losing money twice on the revenue you’ve earned. This is especially hurtful for smaller businesses that don’t have enough wiggle room to get taxed both times. When you pay taxes at the corporate level, it cuts into your earnings.
C Corps don’t allow tax write-offs for owners on their personal income tax returns. This is usually a step that’s taken to offset other income. Unfortunately, it’s not possible at this status.
S Corp vs C Corp Ownership Disadvantages
S Corp Ownership
Because S Corps are more heavily scrutinized by the IRS, breaking any rules could mean you lose your S Corp status. For instance, you’ll need to stay within the 100 shareholder limit and all shareholders must be U.S. residents. Along with that, S Corps only allow one class of stock, while C Corps can have multiple classes of stock. If you’re expecting high growth potential or planning to do international business, this could hurt your company.
S Corps can’t be own by other S Corps, C Corps, LLCs, or trusts. For companies that are hoping to get acquired at some point, this could hurt the sale of your business.
C Corp Ownership
C Corps don’t have ownership restrictions or limits on classes of stock. But you’ll still have to keep your business up-to-date by managing it correctly. If necessary, you’ll need to issue stock to shareholders and hold shareholders and board of directors meetings. If and where applicable, you might need to pay the necessary fees to maintain your C Corp ownership status.
C Corporation vs. S Corporation: The Similarities
- Limited liability protection
- Separate legal entities
- Filing documents
- Corporate formalities
Limited liability protection
This type of protection means shareholders aren’t responsible for a company’s business debts or financial obligations. Both S Corps and C Corps benefit from limited liability protection. If anything were to happen to your company, you wouldn’t have to personally pay out of pocket for expensive financial responsibilities or other debt the company has accumulated. This isn’t the case if you were to have a sole proprietorship.
Separate legal entities
Both C Corporations and S Corporations have the option to use separate legal entities. This is when a company operates as a separate entity from its original company. Separate entities ensure separate liability from its ownership. Separate entities have a corporate shield, or a veil of protection from liability.
When you file your articles of incorporation with your state, the documents will be the same regardless of if you’re filing as a C Corp or S Corporation. While filing for an S Corp requires a bit more documentation, the articles of incorporation are the same.
Both types of corporations allow for their own shareholders and ownership setup. S Corps and C Corps alike are incorporated the same way, as well as issue stock and adopt bylaws. Both S Corps and C Corps have boards of directors with directors and officers and file annual reports.
Both have similar corporate structures, even though shareholders own the company. For instance, company business is managed by the CEO and the team they put together. Boards of directors handle policy and management concerns.
Picking between C Corp and S Corp: Which Is Best for Your Small Business?
Even though C Corporations are the default company filing status, they’re not necessarily right for every business. When you’re deciding which status to choose, ask yourself a few questions, like:
Do I want my company to get acquired?
If you’re hoping to one day sell your company to another one, you might want to become a C Corp. Since C Corporations have the ability to be owned by other types of companies, it makes acquisitions much easier in the long run. Along with that, you can have any many owners as you’d like and many different classes of shareholders.
Do I want to limit my shareholders?
Some companies aren’t made for huge expansions. Some small businesses want to stay that way. Since S Corporations are limited to 100 shareholders and they have to be U.S. citizens, you might feel like that’s enough of a setup for your company. But keep in mind that even with the 100 shareholder limit, S Corporations tend to put more emphasis on shareholder input. You might like the smaller setup. Otherwise, consider filing as a C Corporation if you think your company could face significant growth later on.
Is double taxation worth it?
The biggest differentiator between S Corps and C Corps is that C Corporations face a corporate tax. If you’re comfortable with getting taxed at the corporate level and then again at the personal level, you shouldn’t have an issue with becoming a C Corp. However, if you’d prefer to save on corporate taxes and handle profit and losses through your personal income tax, you can.
Am I OK with the extra scrutiny?
Since the default filing for corporations is C Corps, there’s an extra layer of paperwork to complete for S Corps. Along with that, becoming an S Corporation means you’re subjected to an extra-careful watchful eye from the IRS. You’ll need to make sure you keep a squeaky-clean record, since even one small mistake, like going over the 100 shareholder limit, could cause you to lose your S Corporation status. If you can handle the idea that the IRS is always watching and you don’t feel like you’d have a hard time following the rules, an S Corp might work for you. Otherwise, consider filing as a C Corporation.
Is there another option that works for me?
If neither a C Corp or S Corp works for you, there are other ways you can set up your business. For instance, you can set up your business as a partnership, trust/estate, sole proprietor or LLC. If you’re planning on being the only person in your company, you might benefit from setting up your company as a sole proprietor or LLC. But keep in mind that as a sole proprietor, there’s virtually no distinction between you and your company. If your company accrues debt, you’re personally responsible for paying it off. And if you don’t, your assets could be seized to pay for that debt.
However, as an LLC, your liability is limited to the investment you put into your company. Incorporating as an LLC protects you against potential lawsuits and gives you a much better opportunity of getting funding in the future, whether through a business credit card or a loan. There’s more paperwork involved in becoming an LLC, just like incorporating as an S Corp or C Corp.
How you plan to set up and run your business depends on the type of company you want to run, what you envision for the future and the comfort level of ownership and taxes you’re willing to take on.