Wondering about C Corp vs S Corp?
How do you choose one type over the other?
In this article, we will break down the notion of C Corp vs S Corp so you know all there is to know about it.
We will look at the main differences, the biggest advantages and how to choose the most suitable structure for your business needs.
What is the difference between C Corp and S Corp?
The most notable difference between a C and S corporation is with regards to how they are taxed.
Both the C corps and S corps are corporations and have shareholders.
They are incorporated by filing their articles of incorporation with the state and paying their filing fees.
Once the company is incorporated, an S corporation will need to file additional documents to elect an S corp taxation structure.
When the S corp election is made, the S corp will be taxed under Subchapter S of the Internal Revenue Code in the United States and the C corp is taxed under Subchapter C.
This difference is tax treatment makes an S corporation more attractive from a taxation point of view.
If you don’t make an S Corp election, by default, the corporation will be taxed as a C Corp.
A C corporation is taxed directly on its own income without impacting its shareholder’s taxation (unless the shareholders pay themselves dividends).
You can consider it this way, a C corp is like an independent person earning its own income and paying its own taxes.
An S corp, from taxation point of view, is not independent of its owners and the company income flows to the shareholders.
Formation of S corp vs C Corp
Forming a C corp is a bit simpler than an S corp.
You’ll have less paperwork to deal with when forming a C corporation than an S corporation.
In fact, both S corp and the C corp are corporations that are incorporated the same way.
By default, a corporation will be taxed as a C corp without any further formalities.
An S corporation will require a bit more effort and paperwork to set up.
To create an S corp, you’ll need to draft articles of incorporation, determine the different types of shares your company can issue, establish company bylaws and so on.
You will also have additional forms and documents to submit to the corporate registry than for a C corp as you need to elect the S corp taxation.
On the other hand, if you elect an S corporation for better tax treatment, you may limit the ability of the company to obtain external financing and potentially grow the business to a much larger organization.
Taxation C corporation vs S corporation
S corporations provide individuals with some tax benefits.
An S corporation has elected a special tax status with the IRS and can benefit from some tax advantages.
To elect an S corp status, companies need to file Form 2553 with the IRS and make sure to meet the S corporation guidelines.
Although you’ll need to verify your tax rules, most S corps can deduct up to 20% of their business income on their personal tax returns.
S corporations are pass-through taxation entities.
S corporations file an informational federal return using Form 1120-S and do not pay taxes at the corporate level.
On the other hand, C corporations have what’s called double taxation.
Double taxation is when the company pays taxes on its revenues and if dividends are paid to the shareholders, the shareholders pay taxes on the dividend income as well.
C corporations must file a corporate tax return using Form 1120 and pay taxes at the corporate level.
The tax rate of a C corporation may be lower to compensate for such double taxation.
The revenues of S corps are taxed as personal revenue of the owners.
That can be an advantage but it can also be a disadvantage.
However, the IRS and the tax authorities tend to audit personal tax reports more often and with more attention than C corps.
You’ll need to make sure you file your taxes properly to avoid any penalties, assessments or even the cancellation of your S corp.
On the other hand, C corps allow the company’s income to be taxed in the hands of the company.
The downfall is that if the owners want to get paid some profits, they’ll need to issue dividends to themselves and the dividends get taxed in the hands of the owners.
This is called double taxation.
The company pays taxes on its revenues, then when it pays dividends to its shareholders, they are taxed on the dividends.
Ownership C corp vs s corp
An S corp can have up to 100 shareholders who are required to be U.S. citizens.
The shareholders will have the same rights in the business and have no ranking difference.
On the other hand, you do not have the same limitation of 100 shareholders for a C corp.
C corps can have as many shareholders as needed.
The S corp is a more suitable corporate structure for individuals looking to raise capital, attract investors and create different types of shares granting shareholders different rights.
S corps are not as flexible as C corps when it comes to the ownership structure.
The first limitation is that an S corp cannot have more than 100 shareholders.
All the shareholders must be American citizens.
If you are looking to grow your company, attract investors, get financing and potentially operate internationally, C corp will not be the right structure for you.
S corps have the disadvantage of not being able to own other corporate structures like C Corps or LLC’s.
On the other hand, although a C corp gives you the ability to scale your business, you have to make sure you maintain the company books, manage the shareholders and ensure that you remain in compliance with the corporate rules.
Similarities between C Corporation vs S Corporation
C corporations and S corporations have certain similarities as well.
Let’s look at the main similarities.
Both C corporations and S corporations operate under a separate legal entity.
In other words, the company does not act through its individual shareholders or owners.
A corporation by definition is a separate legal vehicle than its owners or members.
Limited liability protection
Both C corporations and S corporations are “corporations”.
As such, they offer limited liability protection to their shareholders.
The shareholders are sheltered from the company’s debts and liabilities and cannot be personally held responsible for the actions of the company in most cases.
An S corp and C corp are formed in a similar way.
You create your entities by filing your articles of incorporation with the applicable state.
The slight difference is that you will have some additional forms to file to form an S corporation.
C corps and S Corps operate in a similar way.
In other words, in both organizations, you can have an executive team handling the operations of the company.
You can also have a board of directors handling the company policies and exercising oversight on the executives.
Both corporations, C corp or S corp, are corporations and must comply with the local laws.
They must ensure they adopt their bylaws, issue shares to their shareholders, appoint directors to run the business, have meetings, designate a registered office, file their annual reports and pay and yearly maintenance fees.
How to choose between a C Corp and S Corp?
When you start your business, it’s important to consider what type of business you want to establish.
Understanding your overall objectives and goals will help you evaluate if you need a C corp vs S corp.
Here are some questions you can ask to help you make the best choice:
- Will I need financing from investors?
- Can I operate the business with a limited number of shareholders?
- What is the structure that provides me with better taxation?
Most often, small businesses or local businesses will tend to favour an S corporation as they will have a stable and fully American shareholder base.
On the other hand, startups, entrepreneurs, companies with aspirations to grow and expand globally will prefer a C corporation giving them more flexibility to define the most suitable shareholder structure for their needs.
Summary of advantages and disadvantages
Advantages of having an S corporation
S corporations offer the following advantages:
- Single-layer of taxation
- 20% qualified business income deduction
- Pass-through of losses
Advantages of having a C corporation
C corporations offer the following advantages:
- Unlimited number of shareholders
- No restriction on shareholder residency
- No restriction of different classes of stocks
- Lower maximum tax rate
- Better structure to raise capital
Disadvantages of having an S corporation
S corporations offer the following disadvantages:
- A limited number of shareholders
- Shareholder residency restrictions
- Cannot issue preferred shares
- Transfer restrictions
Disadvantages of having a C corporation
C corporations offer the following disadvantages:
- Double taxation
Frequently asked questions
When should I choose an S corp?
You may consider using an S corp when you do not have the expectation of having a complicated share ownership structure or you do not plan on distributing company profits to the shareholders.
Here are some factors that will favour an S corp as opposed to a C corp:
- You do not plan to go public and do an initial public offering
- You will not have more than 100 shareholders
- Your shareholders are all American citizens
- You plan on distributing company profits to the shareholders quite often
- You are ok if all shareholders in the company have the same rights on their shares
- You may have company losses that you may want to deduct from your personal taxes
When should I choose a C corp?
Choosing a C corp over an S corp quite often comes down to your desire to scale and grow the business.
Here are some factors that will favour a C corp as opposed to an S corp:
- You are going to look for external investors
- You may have a complicated shareholder structure with common shares and preferred shares
- You may have shareholders that are not U.S. citizens
- You will not distribute company profits to the shareholders as often
- You do not have any business losses that you’d like to pass through to your personal income return
How do you become a C corporation?
Although this question is asked frequently, the question needs to be reformulated so it’s clear.
You do not become a C corporation.
You must become a “corporation”.
Both a C corp and S corp are corporations and are incorporated the same way.
To incorporate, you’ll need to file your articles of incorporation and with state and pay your filing fees.
By default, your corporation will be taxed as a C corporation under the IRS rules unless you elect to be taxed as an S Corporation.
How do you become an S corporation?
Our comments for the C corporation stand for the S corporation.
You do not become an S corporation.
Whether you want an S corporation or a C corporation, you need to file your articles of incorporation with the state and be legally formed as a corporation.
Once that is done and your company is duly organized, to be taxed as an S corporation, you must file a Form 2553 with the IRS to elect the S corporation taxation.
If you meet the guidelines, you will be authorized to file your taxes as an S corporation.
What is double taxation?
C corporations are subject to double taxation.
The reason why we say double taxation is because the company’s revenues are taxed the first time in the hands of the company.
When the company pays dividends to its shareholders to distribute its profits, the shareholders will be taxed on the dividend income.
This is a second time the same money is subject to a tax.
Let’s look at an example.
The company earns $100,000 and pays $30,000 in taxes.
There’s $70,000 left in the company in net profits.
This money was already subject to a corporate tax and is already net of taxes.
Now the company takes $20,000 of its net profits and pays Mike, the shareholder, dividends.
Mike must report the $20,000 on his personal income and may be taxed another $5,000 on this dividend and he is left with $15,000.
The double taxation name comes from the fact that when Mike pays $5,000 in taxes on the dividends, the money was already taxed in the hands of the corporation.
Can you use an S corp to reduce self-employed income taxes?
An S corporation can have a better tax treatment than self-employed individuals operating as a sole proprietor.
Let’s look at a concrete example.
If Mike is a sole proprietor and earns $100,000 in business income, all that income is taxed in on his personal return.
Depending on his tax bracket, he may lose a good amount in taxes.
On the other hand, if Mike is the shareholder of a corporation that has elected to be taxed as an S corp, Mike will only be personally taxed on the salary that he earns.
If his company earned $100,000 and paid him $50,000 in wages, Mike will only pay personal taxes on $50,000 and not $100,000.
If the company distributes to him an additional $10,000 in profits, the distribution will not be considered as self-employment income and will be taxed as a distribution.
S corp and C corp comparison chart
|C Corporations||S Corporations|
|Incorporation||Filing of articles of incorporation||Filing of articles of incorporationFiling of Form 2553|
|Taxation||Double taxation||Income and loss pass-through|
|ShareholdersNumber||No restrictions||Maximum 100|
|Shareholder Residence||No restrictions||American Citizens|
|Financing Options||More flexible||Not flexible|
|Best candidates||Local businessesBusinesses intentionally kept smallProfit distribution to shareholders||Startups Entrepreneurs Growing businessesLarge organizations|
|IRS Forms||Form 1120Form 1120-WForm 941||Form 2553Form 1120SForm 1120-WForm 941|