S-Corp vs. C-Corp: How They Differ (and How to Decide)

If you choose to structure your business entity as a corporation, you’ll be faced with an important decision—whether to set up your business as an S-corp vs. C-corp. This choice has big implications for how much you’ll pay in taxes, your ability to raise money, and the ease with which you can expand your business.

And when you’re the small business owner—not a lawyer or accountant—it can be hard to understand the differences between S-corporations vs. C-corporations. Or, admittedly, even be moved to care about why you might need to understand it in the first place. After all, isn’t that why you hired someone to get in the weeds with those forms—so you didn’t have to do it?

But the reality is that it’s important you understand the differences between S-corps vs. C-corps, too.

Although you might not be looking at the granular things your accountant or lawyer will, small businesses owners do need to know certain things about these two business entities compare. That way, you’ll have the tools to choose which type of corporation is right for you. Plus, we’ve included some info on the new Trump tax plan, which should help, too.

S-corp vs. C-corp: Know How C-Corporations and S-Corporations Work So You Can Choose

Before we can understand the differences between C-corps and S-corps, let’s look closely at how these two types of corporations work. Here’s what it means to structure your business as a C-corp vs. S-corp. This’ll be the first step in helping you decide between them.

What Is a C-Corporation?

In a C-corporation, individual shareholders who hold shares of the company own the business. That’s the most important part here. The shareholders of a corporation have limited liability protection. Put simply, this means that shareholders of corporations are usually not liable for business debts or liability.

A C-corporation is the default form of a corporation—you know, what you generally think of when you think of a big corporation. So, unless you take specific steps (aka the ones outlined below) to slap an S on your corporation, you have a C-corporation. A C-corp is more common than S-corporations in the US.

The shareholders of a C-corporation own the business but don’t make the decisions. Instead, management and policy issues are left to the company’s shareholder-elected board of directors. 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 articles of incorporation with your state government. And once you’re up and running, you have certain compliance and documentation obligations as a corporation—like issuing stock, paying fees, and holding shareholder and director meetings.

What Is an S-Corporation?

The owners of a corporation can elect to structure themselves as an S-corporation. The split of control among shareholders, the board of directors, and officers is the same in S-corps and C-corps, and shareholders in S-corps also enjoy limited liability. The big difference here, however, is that the owners of an S-corp can take advantage of pass-through taxation. That’s where the profits and losses of the corporation are reported on the owners’ personal tax returns.

An S-corporation also has the same documentation and compliance obligations. S-corps need to file their articles of incorporation, and also need to issue stock, pay certain fees, hold shareholder and director meetings, etc.

→Too Long; Didn’t Read (TL;DR): For an S-corp vs. C-corp, these business entities are really more similar than they are different. But there are differences (more in a bit). The most relevant thing for you to consider is that S-corps are taxed differently using pass-through taxation.

S Corp vs. C Corp: The 3 Main Differences

The differences between S-corps vs. C-corps come down to three major categories: ownership, shareholder rights, and taxation—with the biggest difference being that last one, taxation. While C corporations are subject to the corporate tax rate, S-corps allow for pass through taxation so that business losses and profits are taxed at the owner’s (or owners’) personal income tax rates.

Let’s dig into these tax differences between S-corps vs. C-corps a little more, since this is what will have the biggest impact on your business’ bottom line—and, subsequently, your take home profits.

S Corp vs. C Corp: Difference in Taxation

Taxation is the biggie when comparing S-corps vs. C-corps. If you choose to be an S-corp, you’ll have a different way of being taxed. Let us explain.

C-corps may be subject to “double taxation.” First, the C-corp is taxed at the corporate level when the owners file a corporate income tax return (Form 1120). A C-corp can then be taxed again, at the owners’ personal income tax rate, if corporate income is distributed to the corporation’s shareholders as dividends.

Like we started to mention above, paying taxes as an S-corp is a bit different. Shareholders report their share of the business’ income and losses on their personal tax return. 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 pass-through taxation. Each shareholder’s part of the business’ income and losses passes through to their personal tax returns and is taxed at their personal income tax rate. (Hence, pass-through.)

S-Corp and C-Corp Tax Changes Coming in 2019  

Under the Tax Cuts and Jobs Act—which you might know as the Trump tax plan—there’ll be changes on the way for both C-corp and S-corp taxation. Some of the rules in the new tax bill took effect January 1, 2018, but business owners won’t see the impact of the changes until they file their taxes in 2019 (for the business year 2018).

There are two main things that small businesses need to know about the new rules:

1. The corporate income tax rate for C-corps has been cut from 35% to 21%. That’s a permanent change.
2. Owners of S-corporations and other pass-through entities (like LLCs, sole proprietorships, and partnerships) will be able to deduct 20% of business income on their personal tax returns. Plan for this deduction to expire after 2025, unless Congress extends the law.

More on How the Trump Tax Plan Affects S-Corps vs. C-Corps

These two changes mean that, under the new law, many small business owners, however they’ve structured their businesses, will pay lower taxes. But how will the new law affect your choice between S corp vs. C corp?

It depends, says John Blake, CPA, and partner with New Jersey-based accounting firm Klatzkin & Company, LLP. He explains, “This will have to be analyzed on a case by case basis. In the tax reform, Congress built in the 20% deduction for pass-through entities such as S-corps to make up for the lower C-corp tax rates.”

For C-corps…

• The law provides for a large tax cut for C-corps, but you can’t escape double taxation as a C-corp. The company will first be taxed at the 21% rate, but once a C-corp makes a certain amount of revenue, they’re expected to pay dividends. And those are subject to taxes on the personal tax return.
• So, if you’re planning to make distributions to shareholders or to pay yourself a salary, then double taxation could still result in a larger tax bill compared to an S-corp.
• On the other hand, if your business is in the growth stage and you’re planning to reinvest most profits back into the business, the C-corp tax cut might even work in your favor.

For S-corps…

• The 20% deduction for S-corps and other pass-through entities levels the playing field with C-corps. Blake says that all businesses with less than $157,500 in annual income (for single filers) and $315,000 (for married joint filers) can take full advantage of the deduction.
• After this, there are limits based on the type of business, the amount of income, and the amount of wages you pay to employees. Professional service businesses like lawyers and doctor’s offices have the most limitations.

The only way to know whether a S-corp vs. C-corp structure is better for you taxwise is to crunch the numbers for your business, based on your projected profits for this year and future years. Your accountant or business lawyer will help you figure out the structure friendliest to your bottom line.

→TL;DR: There are pretty big differences in taxation between S-corps vs. C-corps—especially with new regulations from the Trump tax plan. S-corps use pass-through taxation while C-corps don’t—but C-corps enjoy a bigger tax break.

S Corp vs. C Corp: Difference in Ownership

Another major difference between S-corp vs. C-corp structures is the restrictions on corporate ownership. C-corporations provide a bit more flexibility if you’re looking to expand your business or sell it to another company.

C-corporations have no restrictions on ownership. That means that you can have an unlimited number of shareholders. S-corporations, on the other hand, can have only up to one hundred shareholders. Shareholders of an S-corp must be United States citizens or permanent residents (non-resident aliens aren’t included), whereas C-corps are open to foreign investors.

Further, an S-corp can’t be owned by a C-corp, other S-corps, LLCs, general partnerships, or most trusts. C-corporations can be owned by other corporations, LLCs, or trusts.

→TL;DR: C-corps have a bit more flexibility in issuing stock if that’s a consideration for you.

S Corp vs. C Corp: Difference in Shareholder Rights

One final difference between S-corps vs. C-corps has to do with shareholder rights. Both S-corps and C-corps issue stock to shareholders to sell pieces of ownership in the business.

However, S-corporations are limited to one class of stock, meaning that there’s one kind of shareholder. So, there’s no hierarchy or difference between any one shareholder of the business. Shareholders of S-corporations all have equal voting rights.

It’s quite a bit different in C-corps, in that C-corps can have different strata of shareholders at the top. That basically means that C-corps can divide up their voting rights by issuing different classes of stock.

What that basically means is that the different classes of stock and voting rights in a C-corporation value some shareholders votes over others. Typically, a C-corporation’s early-on owners and founders have the most say when voting—and the most control over the business.

→TL;DR: C-corps have a bit more flexibility in creating different levels of shareholder rights if you care about that, too. There’s only one class of stock in an S-corp, whereas there are different strata in a C-corp.

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? A lot of the benefits and disadvantages of both entities lie in those three differences we just outlined, so you might already have a clear picture. But let’s run through why you should (or shouldn’t) choose one of these business entities.

C-Corporations: Advantages and Disadvantages

Here’s what might you make lean toward a C-corp in the S-corp vs. C-corp question:

Advantages of a C-Corp

• New corporate tax rate. Under new Trump tax reforms for FY18, filed in 2019, C-corporations will have a flat tax rate of 21%, down from 35%. That’s prompted many businesses to consider structuring as a C-corporation.

• A few additional 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.

• No shareholder limit. C-corps can have as many shareholders as they want. Also, C-corps can have foreign (non-resident alien) shareholders, making it an ideal business entity for any company that intends to deal overseas.

• Easier to raise money. It’s easier to raise money for your business if it’s a C-corp, since 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 toward the business. Another benefit to note is that other businesses can own C-corps outright, which might be a better fit for companies looking to be acquired.

• 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 corporation still exists in perpetuity.

Disadvantages of a C-Corp

• Double taxation. C-corps may pay more in taxes due to double taxation. The company’s revenue will be taxed at the corporate level and then again at the personal level if it’s distributed as shareholder dividends.

• No personal write-offs. Another tax-related downside 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 varies 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, create corporate bylaws, and so on. And once you’re set up as a C-corporation, there are strict compliance requirements.

Bigger companies benefit from having unlimited growth potential under a C-corp but typically pay a little more in taxes, reducing their net income. They also spend a little more effort complying with more regulation. But this calculus could change with the new tax laws, however, as C-corporation owners will end up paying less in taxes.

S Corporations: Advantages and Disadvantages

And let’s do the same for an S-corp in the S-corp vs. C-corp question:

Advantages of an S-Corp

• 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.

• Deduction of business income. The Trump tax plan allows owners of S-corps and other pass-through entities to deduct 20% of their business income on their personal tax return, which can significantly reduce your tax burden.

• 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.

• 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.

Disadvantages of an 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.

• Limited stock flexibility. S-corps also prevent you from issuing preferred stock and different classes of stock, which can make it harder to raise money from investors and incentivize early owners.

• Tax qualifications. In general, S-corps tend to have more IRS scrutiny. If you make a mistake (like going over 100 shares or missing a filing deadline), the IRS can terminate your S-corp status—and you’ll be taxed as a C-corp.

• 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.

→TL;DR: If you’re starting a business that you plan on keeping fairly small, with fewer than 100 shareholders and totally in the US, you probably want to be an S-corp. But if you have big plans for growing your company, you might want the flexibility to take on investors, raise capital, issue different kinds of stock, and invite foreign investors into your business as a C corp.

Setting Up Your Business as a C-Corp or an S-Corp

You’ve run through the pros and cons of S-corp vs. C-corp structures and are all systems go on one of the two. Awesome. Now you actually have to set up your business.

Although nuances are different on a state-by-state basis, these directions will help.

How to Structure Your Business as a C-Corporation

Here’s how you take the next steps and formally structure your business as a C-corp:

1. Choose your business’s legal name, and file it with the secretary of state in your state.
2. File your articles of incorporation with your secretary of state. (There’ll be a fee for this!)
3. 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.
4. Next up, apply for your business licenses and permits specific to your industry and your state.
5. 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 loans, and so on.
6. 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.

Need more help? Online legal services such as LegalZoom, Rocket Lawyer, and IncFile make it faster and easier to file articles of incorporation. For a flat rate of $50 to $200, these companies will help you create customized articles your business and file the paperwork on your behalf. The turnaround is typically three days to two weeks. Not bad!

How to Structure Your Business as an S-Corporation

Good news: Since an S-corporation is just a tax election, it’s almost the exact same process as setting up a C-corp:

1. Follow Steps 1 through 6 for setting up a C-corporation.
2. 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.

Voila! Becoming an S-corp just takes one more step.

If you’re currently a C-corp and you want to switch to become an S-corp, then you’ll need to get the board’s approval. Remember 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 (again).

And, a reminder: Take care in switching from a C-corp to an S-corp because there are often taxes that are assessed as a result of the switch that make the switch cost prohibitive. Make sure you really analyze, with the help of an accountant or business lawyer, which structure will save your business more money in the long run.

→TL;DR: Structuring as a C-corp starts with filing articles of incorporation in your state’s secretary of state office. You’ll then have to draft corporate bylaws and hold your first board meeting. Creating an S-corp is exactly the same, and just requires one extra step form to file. You can snag some online legal help to speed up the process.

Making the Right Choice on an S-Corp vs. C-Corp

Now that you know the differences between an S-corp vs. C-corp, plus their advantages and disadvantages, you’re well equipped to make a smart choice for your business.

Here are the main things to keep in mind:

• C-corps and S-corps have some things in common—shareholders in both types of companies have limited liability protection; and control of the company is split among shareholders, a board of directors, and officers.
• The biggest difference in the two types of corporations is taxes: C-corps are subject to the corporate tax rate, while S-corps are pass-through entities.
• To organize as a corporation, you have to file articles of incorporation with the secretary of state in your state, and there’s one more form to file with the IRS to be an S-corp.
• C-corp structure is best for larger companies with big growth potential and that want to raise money and issue different types of stock options.
• S-corp structure is best for smaller businesses.
• Tax changes for FY18, filed in 2019, will affect both C-corps and S-corps.

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.

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