WhileS corpandC corpmay sound similar, there are some key differences in how these two entity types are taxed, what kinds of shareholders they can have, and how they must operate. It’s important for any small business owner to understand these differences in order to make early stage decisions on your business structure that might affect long-term payouts to shareholders.
What is an S corp?
An S corporation (S corp) is a legal entity and tax designation defined by its pass-through tax status. By electing to be taxed under Subchapter S of the Internal Revenue Code, S corps may forgo paying corporate taxes and instead pass all corporate income, losses, deductions, and credits through to shareholders for purposes of federal taxations. Those shareholders then report the distributions on their personal tax returns, and taxes are assessed at their personal income tax rates. This allows an S corp to avoid double taxation on corporate income.
How to form an S corp
To form an S corp, a small business owner must ensure the organization meets certain requirements set forth by the US Internal Revenue Service:
Choose a unique, unregistered business name (try ourbusiness name generator).
- Appoint a board of directors, registered agent, and other corporate officers.
- Hold annual board meetings. Boards must keep detailed minutes of these meetings.
- File articles of incorporation with the IRS and secretary of state in your state of incorporation.
- Write and file bylaws, which govern appointing and removing board members, issuing stock, scheduling meetings, and conducting board votes.
- Issue stock. S corps may not issue stocks to more than 100 shareholders. These shareholders must be legal persons (not corporations) who are US citizens or permanent residents.
- File tax forms. S corps must file aForm 2553(Election by a Small Business Corporation) with the IRS.
- Apply for state, county, and local business licenses.
- File aForm SS-4to obtain an employer identification number (EIN) from the IRS.
What are the pros and cons of S corps?
S corps providea number of advantagesto business owners and shareholders, namely with regards to liability and tax treatment.
Advantages of S corps
- Shareholders in S corps enjoy limited liability protection because, under this structure, the business itself is entirely separate from its shareholding class. If the business is sued, plaintiffs cannot access the personal assets of shareholders.
- An S corp is a pass-through entity, meaning corporate profits and losses pass through to ownership and shareholders. As a result, S corp owners are not federally taxed at the corporate level. Those taxes are paid at the personal level by shareholders who receive distributions. An added bonus of avoiding corporate business taxes is that S corps can reinvest earnings back into the company, instead of issuing dividends, at a far lower tax burden.
Disadvantages of S corps
- There is a ceiling to the amount of funding an S corp can access through issuing shares, for example—S corps may only have 100 shareholders who are non-corporate US citizens or permanent residents.
- Because of its pass-through tax benefits, S corps are often scrutinized closely by IRS officials to discourage disguising taxable payments (like employee salaries) as pass-through distributions.
What is a C corp?
A C corp is a company that issues stocks to shareholders and that is run by a board of directors. Big US companies like Microsoft and Walmart are C corporations—that is, their income is taxed under Subchapter C of the United States Internal Revenue Code. The key defining features of C corps lie in liability and tax treatment, however. Like S corps, C corps shield their shareholders from business-related liability. Anyone who sues a C corp cannot reach the personal assets of its shareholders. Most unique of all, C corps are taxed on corporate income, and shareholders are taxed again on any dividends they receive from the company. This is called “double taxation.”
C corps are considered the default corporation type. When you file articles of incorporation in your state of choice, the state will recognize your new corporation as a C corp, unless you file Form 2553 and ensure all other S corp formation requirements are met.
How to form a C corp
In quick summary, the requisite steps for forming a C corp are as follows:
- Register a unique business name.
- Appoint officers to the corporation, including a CEO, registered agent, and board of directors.
- 和文件章程草案secretary of state in your state of incorporation.
- Draft and file company bylaws.
- Issue stock.
- Register with the US Securities and Exchange Commission. C corps that issue stocks to fewer than 35 shareholders do not need to register with the SEC.
- Apply for state, county, and local business licenses.
- File aForm SS-4to obtain an employer identification number (EIN) from the IRS.
Pros and cons of C corps
There are numerous benefits to forming and operating your small business as a C corp, aside from limited legal and financial liability for shareholders:
- Ease of access to funding through selling stock—there’s no limit here.
- Shares are freely transferable; anyone can own stock, even corporations.
- Attractive to investors looking forpassive income.
There are, of course, drawbacks too. C corps can be expensive to form compared with other structures, likeLLCsorsole proprietorships. Because of the structural requirements (boards of directors), business operations can be relatively complex. They are also subject to double taxation.
S corps vs. C corps: similarities and differences
Here’s an overview of the key similarities and differences between the two types of corporations.
Fundraising
- How they’re similar:Both can be funded through the issuance of stock.
- How they’re different:C corps can issue common or preferred stock. Common stock comes with voting privileges; preferred stock comes with no voting privileges, but preferred stockholders jump the line in terms of priority when it comes to receiving dividends, or payouts if a company is liquidated. S corps are limited to offering one class of stock.
Who can be shareholders
- How they’re similar:Both S corps and C corps allow shareholders, which means multiple people can own portions of the business.
- How they’re different:S corps must observe rules about the number of shareholders and who their shareholders can be that C corps do not. S corps may issue shares to a maximum of 100 shareholders, all of whom must be actual people (not corporations) who are US citizens or permanent residents. C corps may issue as many shares as they like to anyone or anything they like: corporations, nonprofits, citizens of foreign countries even.
Taxes
- How they’re similar:Shareholders for both S corps and C corps pay personal-rate taxes on corporate distributions. (These are usually referred to as “dividends” when issued by C corps.) Both shield shareholders from corporate liability, protecting their personal assets in the event of litigation.
- How they’re different:C corps pay taxes on corporate income, and their shareholders pay personal taxes on any distributions from the company, meaning dividends are essentially taxed twice. S corps enjoy pass-through tax treatment, meaning shareholders pay personal income taxes on distributions from the company only.
Operations
- How they’re similar:Both S corps and C corps require appointing corporate officers; e.g., a board of directors. These boards must meet at least annually and keep detailed minutes of each session. Both entity types must draft, file, and abide by company bylaws regarding the makeup and voting of boards, issuance of stock, scheduling of annual meetings, etc.
Final thoughts
Choosing between types of corporations requires small business owners to ask a number of important questions:
- Do you need or want to raise money for your company by issuing stock?
- Do you foresee having investors who are foreign or business entities?
- Do you ever intend to sell your company?
- How large of a shareholder pool do you envision in the immediate future? In five years?
- Can you afford double taxation? If not, can you bear the extra IRS scrutiny?
Navigating these questions will likely lead you to the best option for your business. But if not, don’t worry—you are not trapped in a dichotomy of S corps and C corps. Perhaps an LLC, partnership, or even a sole proprietorship is a better fit for your needs.
See our state specific guides forCalifornia LLC,Texas LLCandFlorida LLC.