As entrepreneurs consider the best business structure for their ventures, they may weigh the benefits of a Limited Company (LLC) against those of an S corporation or C corporation. In this article, we will explore the advantages and disadvantages of S corps and C corps, highlighting the key differences between the two. Despite their similar names, these two corporate structures have distinct characteristics that can impact a business’s operations and success.
What Is a C Corp vs an S Corp?
When establishing a corporation at the state level, the appropriate course of action is to submit Articles of Incorporation (or a Certificate of Incorporation in some states) to the Secretary of State or other relevant agency responsible for corporate registration. The state does not differentiate between C and S corporations, and instead recognizes all businesses as corporations.
Corporations are distinct legal entities that provide liability protection, meaning that the owners are generally not held personally responsible for any debts incurred by the business.
Both C corporations and S corporations must adhere to specific corporate formalities, including the issuance of stock, the adoption of bylaws, the appointment of registered agent, and the holding the shareholder meetings.
Most states mandate that corporations file an annual report or statement of information (some require biennial reports) and may require the payment of an annual (or biennial) filing fee.
It is important to note that all these fundamental requirements remain the same regardless of whether a business elects to pursue S corporation status or remains a C corporation, which is the default.
S Corp vs C Corp Differences
What distinguishes S corporations from C corporations are primarily two factors: taxation and ownership. It is important to note that the decision to become an
S corporation is made for tax purposes. A corporation may elect to be taxed under Subchapter S of the Internal Revenue Code by submitting IRS Form 2553 to the IRS. Failure to do so will result in taxation under Subchapter C of the IRS code, which is commonly referred to as a C Corp. However, not all corporations are eligible for S corp status. The business must meet specific IRS requirements regarding the maximum number and type of shareholders. C corporations are subject to double taxation, where the corporation pays corporate income tax and shareholders pay federal income taxes on dividends. In contrast, S corporations are pass-through entities, meaning that the corporation itself does not pay taxes. Instead, shareholders report business income (and losses) on their personal tax returns. Regarding ownership, C corps have no restrictions, and anyone can be a shareholder, including foreign individuals or entities and other businesses. Conversely, S corps are limited to 100 shareholders who must be U.S. citizens and individuals. Lastly, S corporations only have one class of stock, while C corporations may have multiple classes of stocks, such as preferred or common stock.
The most significant distinction between C and S corporations pertains to their tax treatment. C corporations are subject to taxation on their income at the corporate level, in addition to shareholders being liable for taxes on the profits distributed as
dividends. On the other hand, S corporations do not directly pay income taxes. Rather, they submit IRS Form 1120S, which serves as an informative return that discloses income and expenses to the IRS. Subsequently, profits or losses are reported on Form K-1, which the proprietors file with their personal tax returns. Once again, profits or losses are passed through to the individual shareholders.
If one is amenable to more restricted ownership options, an S corporation may be a viable choice. It is important to note that up to 100 shareholders are permitted, all of whom must be United States citizens. However, it is not possible for another corporation, trust, or LLC to own an S corporation. Additionally, only one class of stock is permitted. In contrast, C corporations do not have any ownership restrictions. If one intends to sell their company in the future or is seeking funding through investors, a C corporation is often the preferred option. There is no limit to the number of shareholders, and shareholders can include other C corporations, S corporations, other corporations, trusts, and foreign owners. Multiple classes of stock are permitted, allowing for shareholders with and without voting rights.
Why Choose an S Corp
S corporations are a popular choice among small business owners who earn high incomes and have one or two owners, as they seek to reduce their tax burden. As previously mentioned, owners have the option to pay themselves a salary subject to payroll taxes, as well as distributions that are not. Additionally, S corp owners may take advantage of various business tax deductions and deduct losses. In contrast, C corps may face double taxation and higher tax preparation and filing costs. Overall, forming and maintaining an S corp is easier than a C corp, and financing options are plentiful provided that the lender’s requirements for time in business and revenues are met. Choosing an S corp over a sole proprietorship or C corp may result in cost savings, but the amount saved will depend on the business’s profit, personal income tax rate, and other factors. Seeking the guidance of a tax professional can help determine the best option for the business.
Why Choose an C Corp
If you aspire to sell your company to another entity or secure venture capital or other investment funding, it may be advantageous to operate as a C Corporation. C Corporations offer a high degree of flexibility in terms of ownership and the types of shares of stock that may be offered, making them more attractive to investors and potential acquisition targets. Additionally, C Corporations can have numerous owners and different classes of shareholders. Another potential benefit of a C Corporation is the ease of access to small business loans and corporate credit cards without requiring a personal guarantee. However, the corporation must still meet lender requirements in terms of revenue and time in business, particularly for startups that are considered high-risk. If these requirements are met, the corporation may be able to obtain financing solely in the name of the business.
KEEP IN MIND
It is possible to establish an S corporation presently and subsequently transform it into a C corporation. This process will necessitate documentation and potentially incur supplementary expenses to engage the services of a legal professional and/or a certified public accountant to facilitate the conversion. Nevertheless, it is reassuring to be aware of the available alternatives.
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