When you’re just starting a business, you have a lot of momentum behind you.
You’ve got the perfect business idea, you’ve written all of it down into a stellar business plan, and you even have a catchy, one-of-a-kind business name.
That’s it, right? You’re ready to roll.
Not just yet. Many aspiring small business owners come screeching to a halt when they realize that before they open their doors for business, they need to choose a business entity—and choose carefully and deliberately.
But as a small business owner, not a lawyer, you can easily get lost in all the business entities there are to choose from. S corp vs. C corp vs. LLC vs. sole proprietorship … how are they different, and which one is right for you?
Let’s look closely at the corporation structure, specifically an S corp vs. C corp. Here are all the differences small business owners need to know—and how to choose the best one for your business.
What Is a C Corporation?
A C corporation is a standard business entity for small businesses and is probably what most people think of when they think of a typical business.
Technically, a C corporation is the same as a corporation and is the default formation of a corporation—unless you slap an S on your corporation, you have a C corporation. A C corp is the most common type of corporation in the United States.
In a normal C corporation, the business is owned by individual shareholders who hold shares of the company. This means that corporations are separate legal entities. Corporations have what’s called liability protections. Put simply, shareholders of corporations are usually not liable for business debts or liability.
The shareholders have control over larger policy issues regarding the company, but business issues are left to the company’s board of directors, who are elected by the shareholders.
The normal, day-to-day work of running the business is on the officers of the C corporations—like the CEOs, COOs, and CTOs.
If you want to structure your business as a C corporation, you have to file certain documents with your state government. In almost all cases, these are articles of incorporation. And once you’re up and running, you have certain compliance and documentation obligations as a corporation—like issuing stock, paying fees, holding shareholder, and director meetings.
What Is an S Corporation?
An S corporation, on the other hand, is just a slight variation of a C corporation.
An S corporation is structured just the same as a C corporation: Shareholders own the business and some high-level decision making, the board of directors (appointed by the shareholders) dictate the direction of the business, and executive officers manage the day-to-day activities of the business.
An S corporation also has liability protection—shielding the shareholders from any responsibility for business debts and liabilities. An S corporation also has the same documentation and compliance obligations. S corporations need to file their articles of incorporation and need to issue stock, pay certain fees, hold shareholder and director meetings, and so on.
When it comes S corp vs. C corp, you’ll find that both business entities are really more similar than they are different.
But with that being said, there are some key differences between an S corp vs. C corp that you need to consider before choosing between the two.
S Corp vs. C Corp: The 3 Main Differences
So, S corps vs. C corps … what are the differences you need to know?
The differences between S corps vs. C corps come down to three major categories: ownership, shareholder rights, and taxation—with the biggest difference being taxation.
S Corp vs. C Corp: Difference in Ownership
One of the major differences between S corp vs. C corp structures is the restrictions on corporate ownership.
C corporations have no restrictions on ownership.
That means that, if you were to structure as a C corp, you can have an unlimited amount of shareholders.
S corporations, on the other hand, can have only up to 100 shareholders. Also, shareholders of an S corp must be United States citizens or residents.
And further, an S corporation can’t be owned by a C corporation, other S corporations, limited liability corporations (LLCs), partnerships, or most trusts. C corporations can be owned by other corporations, LLCs, or trusts.
S Corp vs. C Corp: Difference in Shareholder Rights
Both S corps and C corps are structured with shareholders at the top.
But a main difference in shareholder rights between the two is this:
S corporations are limited to one class of stock, meaning that there is one kind of shareholder: There’s no hierarchy or difference between any one shareholder of the business. Shareholders of S corporations all have equal voting rights.
But C corps are a little different.
C corps can have different strata of shareholders at the top—mostly due to the fact that C corps can divide up their voting rights by issuing different classes of stock.
Put simply, the different classes of stock and voting rights mean that some shareholders’ votes count more than others’. Typically, a business’s early-on owners and founders have the most say when voting—and the most control over the business.
S Corp vs. C Corp: Difference in Taxation
When it comes to the differences between S corps vs. C corps, taxation is the biggie.
If you choose to be an S corp, you’ll have a different way of being taxed.
The IRS treats a C corp as a separate taxable entity. A C corp is taxed at the corporate level, and they file a corporate tax return (Form 1120). A C corp can then be taxed once again at the personal income tax level if corporate income and payments are distributed to the corporation’s shareholders.
All this means is that a C corp is subject to “double taxation.”
Paying taxes as an S corp is a little different. As an S corp, the income and losses of the business are divided among the shareholders and are taxed only at the personal income tax level—they aren’t subject to the corporate tax. As a shareholder of a S corp, your business’s income is taxed on your personal income when you file Form 1120S.
This is why an S corp is subject to a “pass through” tax.
S Corp vs. C Corp: How to Decide Between the Two
Now that you know the three major differences between an S corp vs. C corp, how can you decide between the two business entities?
Well, a lot of the benefits and disadvantages of both entities lie in those three differences we just outlined.
Let’s run through why should (or shouldn’t) choose one of these business entities.
C Corporations: Advantages and Disadvantages
When it comes to choosing an S corp vs. C corp, what might make you sway the way of a C corp?
Here are five distinct advantages of structuring your business as a C corp:
- Limited liability. C corps (and S corps, too) have limited liability that protects the corporation’s directors, officers, shareholders, and employees from the business’s debts and obligations.
- Perpetual existence. Both C corps and S corps have what’s called “perpetual existence.” This means if the original owner moves on or passes away, the C corporation still exists in perpetuity.
- No shareholder limit. C corps can have as many shareholders as they want. Also, C corps can have foreign shareholders, making it an ideal business entity for any company that intends to deal overseas.
- Easier to raise money. It’s a little easier to raise money for your business if it’s a C corp because C corps can issue multiple classes of stock to an unlimited number of shareholders. Plus, investors face no liability for the corporation’s mistakes—making it much easier to put money towards the business. Another benefit to note is that C corps can be owned by other businesses, which might be a better fit for companies looking to be acquired.
- A few tax benefits. C corporations can deduct the cost of fringe benefits provided to employees—like disability and health insurance. Shareholders of a C corporation don’t pay taxes on their fringe benefits, as long as 70% of the corporation receives those same fringe benefits.
While those five benefits make a C corporation ideal for growing, larger business dealing overseas, here are two disadvantages to consider.
- Double taxation. C corps certainly pay more in taxes due to the double taxation effect. It’s inevitable that the company’s revenue will be taxed at the corporate level and then again at the personal level once it’s distributed as shareholder dividends. Another tax-related downside of running a C corp is that owners can’t write off the losses of the business in their personal income statements—offsetting income from other sources.
- Regulations and compliance. Not only is filing your articles of incorporation expensive—think $100 to $200—structuring as a corporation is complicated. The process will vary state by state, but in most states, you have to file your articles of incorporation, create organizational resolutions that set the rules, appoint a board of directors, issue stock, and so on. And once you’re set up as a C corporation, there are stricter compliance requirements.
When it comes down to it, bigger companies benefit from having unlimited growth potential under a C corp but will pay a little more in taxes and spend a little more effort complying with more regulation.
S Corporations: Advantages and Disadvantages
To help you with your S corp vs. C corp decision, let’s run through the advantages and disadvantages of incorporating as an S corp.
Here are five advantages of an S corp to consider.
- Limited liability. Just as C corps enjoy limited liability, shareholders, directors, owners, and employees enjoy limited liability as an S corp, too.
- Perpetual existence. Again, S corps exist in perpetuity—regardless of what happens to the original owner.
- Pass-through taxation. The taxation structure of a S corp is undoubtedly its biggest benefit. S corps don’t have to pay taxes on the business’s income twice. Avoiding double taxation is a huge benefit for smaller businesses.
- Tax filing requirements. Owners of S corps can write off their business’s losses on their individual tax returns. This is a benefit for newer corporations that are likely operating at a loss for the first few years. As the owner, you can write off the losses of the business on your personal income statements, offsetting your income from other sources. Also, S corps file their taxes once a year, unlike the quarterly filing of C corps.
- Investment opportunities. S corps can attract investors and issues shares of stock to grow their business.
Here are three disadvantages to weigh against those five general advantages of structuring as a S corp:
- Limited ownership. Unlike C corps, S corps have a set cap on the number of shareholders they can take on—up to 100 shareholders. Plus, shareholders have to be legal residents of the United States. This poses a problem for high-growth businesses or businesses looking to conduct business affairs internationally.
- Tax qualifications. The IRS is strict on filing taxes as an S corp. If you make any mistakes filing the different requirements, the IRS can terminate your S corp status—and you’ll be taxed as a C corp. And in general, S corps tend to have more IRS scrutiny. Payments to employees and shareholders of a S corp could be distributed as either salaries or dividends. Both are taxed differently, so the IRS keeps a close eye on your tax filing.
- Regulation and compliance. An S corp shares the same disadvantage of a C corp—both entities have to worry about a more involved structuring and organizational process, and will have to keep up with compliance issues and documentation throughout the life of their business.
The Bottom Line
When it comes to structuring as an S corp vs. C corp, the bottom line is really this:
If you’re starting a business that you plan on keeping fairly small, with fewer than 100 shareholders and totally in the United States, you probably want to be an S corp. You’ll have the benefits of limited liability and perpetual existence, but you won’t have to worry about paying more due to the double taxation effect.
On the other hand, if you’re starting a business with a big future, you’ll be better off with the flexibility to take on investors, raise capital, issue different kinds of stock, and invite foreign investors into your business as a C corp.
Because S corps and C corps share a lot of the same advantages and disadvantages, the decision between S corp vs. C corp comes down to the plans you have for your business.
Thinking big—really big? Go C corp and stomach the double-taxation effect. If you have smaller plans, an S corp might be a better fit.
How to Structure Your Business as a C Corporation
So, you’ve considered your pros and cons list for S corp vs. C corp structures and have decided to go with a C corporation.
Here’s how you take the next step and formally structure your business as a C corp:
- Choose your business’s legal name, and file it with the secretary of state in your state.
- File your articles of incorporation with your secretary of state. Note that this set will come with a fee.
- Now you’ll have to draft corporate bylaws and hold a board of directors’ meeting. Once you’ve received a note from your secretary of state confirming the acceptance of your articles of incorporation, you should next issue stock certificates to your initial shareholders.
- Next up, apply for your business licenses and permits specific to your industry and your state.
- File your Form SS-4 with the IRS, either online or in person. This assigns your business an Employer Identification Number (EIN). You need to do this even if you don’t plan on hiring any employees in the near future. This will be important for opening a business bank account, applying for a small business loan, and so on.
- Check with your local and state government for any other ID numbers your business might need to legally operate. These vary from one jurisdiction to another, so check in to make sure you have every ID number you need.
Follow those six steps, and you’re on your way to operating your C corporation.
How to Structure Your Business as an S Corporation
Say that, in the debate between S corp vs. C corp, you went S corporation.
How can you set up your S corporation and get the ball rolling?
Because an S corporation is just a tax election from a C corporation, it’s actually almost the exact same process as setting up a C corp.
- Follow Step 1 to Step 6 for setting up a C corporation exactly.
- File your Form 2553 with the IRS within 75 days of your corporation formation. All shareholders must sign and file this form to elect your corporation to become an S corporation.
As you can see, becoming an S corp just takes one more step beyond being a C corp. Remember, though, that remaining an S corp depends on your ability to keep up with the appropriate tax documents that specify your business as an S corp. If you mess up your filing requirements, you risk losing your S corp status and becoming a C corp.
S Corp vs. C Corp: Making the Right Choice
Now that you know the exact differences of an S corp vs. C corp, plus their advantages and disadvantages, you’re well equipped to make a smart choice for your business.
But remember, the way you structure your business is a big decision and has big implications on your business’s future. If you don’t feel sure about choosing your business entity or correctly structuring your company, consider talking to a small business lawyer or accountant.
This stuff is complicated and time consuming, but you want to get your business off on the right foot!
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