C Corp vs. S Corp: Detailed Comparison and Tips

Article by Adeel Qayum 8 Aug, 2023

Considering incorporating your business? While forming an LLC or registering as a sole proprietor might be the first options that come to mind, they’re not your only choices. Corporations, specifically S Corps and C Corps, could offer benefits that align better with your business needs.

Forming a corporation gives you more credibility in the business world. It can make your business seem more established and reliable to customers, partners, and investors. Plus, it provides the added advantage of shielding your personal assets from any business liabilities.

The choice between C Corp and S Corp comes down to their different rules for taxation and ownership. We’ll delve into those differences so you can make the best choice for your business.

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What is a C Corp?

A C Corporation is a company run by a board of directors. C Corps issue stocks to shareholders and are taxed under Subchapter C of the Internal Revenue Code. Large US firms like Walmart and Microsoft are C corporations, meaning their shareholders are protected from business-related liability.

Most US states recognize newly formed corporations as C Corps, making them the default corporation type. These firms are taxed on corporate income, and their shareholders are taxed again on any dividends they receive from the business. As such, C Corp owners are subject to double taxation.

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Pros and cons of C Corps

Forming and operating a business as a C Corp offers plenty of benefits beyond the limited financial liability for shareholders.

Advantages of C Corps

There is no limit on funding access through stock selling.
Shares can be transferred freely; anyone, including corporations, can own stock.
It appeals to investors in search of passive income.

Disadvantages of C Corps

C Corps can be more costly to establish than other business structures
They require structural elements such as boards of directors, making business operations more complex.
C Corps face the burden of double taxation.

How to form a C Corp

Want to start a C Corp? Here are the steps:

Choose a unique business name.
Appoint a CEO, board of directors, and registered agent.
File articles of incorporation with your state’s secretary.
Draft and submit company bylaws.
Issue stock.
If issuing stock to over 35 shareholders, register with the Securities and Exchange Commission.
Apply for local and state business licenses.
Submit Form SS-4 to the IRS to get an employer identification number (EIN).

What is an S Corp?

An S Corp (S Corporation) is a legal entity with a pass-through taxation status. This status allows it to pass all corporate income, credits, losses, and deductions to its shareholders for federal taxation. Consequently, shareholders include these distributions in their personal tax returns, and the tax obligations apply at their individual income tax rates.

Pros and cons of S Corps

S Corps offer a range of benefits to business owners and shareholders. However, there are also a few drawbacks of registering your entity as an S Corp.

Advantages of S Corps

S Corp shareholders have limited liability protection; the business entity is separate from its shareholders.
Legal disputes targeting the business can’t impact shareholders’ personal assets.
As a pass-through entity, S Corp lets corporate profits and losses go directly to shareholders.
S Corp owners don’t have to pay federal income tax on company profits.
Shareholders enjoy personal income tax rates on distributions.
S Corps can reinvest profits back into the company at a far lower tax rate than other entities.

Disadvantages of S Corps

S Corps face limitations in funding through share issuance; they can only have up to 100 non-corporate US citizens or permanent resident shareholders.
S Corps are often under close IRS scrutiny due to their pass-through tax benefits, which can potentially be misused to hide taxable payments (like employee payments) as pass-through distributions.

How to form an S Corp

As a small business owner, you can form an S Corp by meeting the following requirements:

Pick a unique business name.
Appoint your board of directors, corporate officers, and a registered agent.
Hold annual board meetings and record the details.
Submit articles of incorporation to your state’s secretary and the US Internal Revenue Service.
Write bylaws to guide stock issuance, meetings, board votes, and changes in the board members, then file them.
Issue stock to a maximum of 100 shareholders who are legal US residents and not corporations.
File a Form 2553, also known as Election by a Small Business Corporation, with the IRS.
Apply for business licenses at local, county, and state levels.
Request an employer identification number (EIN) from the IRS by submitting a Form SS-4.

C Corp vs. S Corp: similarities and differences

Fundraising

Similarities: S Corps and C Corps both raise funds through selling stock.

Differences: C Corps can issue both common and preferred stock, while S Corps are limited to a single class of stock.

Operations

Similarities: Both S Corps and C Corps require detailed record-keeping, annual meetings, and a board of directors. They both operate according to bylaws.

Differences: There are no significant differences in the operational requirements of S Corps and C Corps. Both entity types must draft and abide by company bylaws concerning stock issuance, meeting schedules, and board operations governance.

Taxes

Similarities: Shareholders in both S Corps and C Corps pay taxes at the personal rate on corporate distributions. Additionally, both structures protect shareholders’ personal assets from corporate liabilities.

Differences: C Corps encounter double taxation; they pay taxes at the corporate level, and shareholders also pay taxes on dividends. S Corps avoid this through pass-through taxation, where shareholders only pay personal income taxes on company distributions.

Shareholders

Similarities: Both S Corps and C Corps allow for multiple owners through shareholders.

Differences: S Corps limit shareholding to 100 US citizens or permanent residents. C Corps face no such limits and can issue shares to any entity, be it foreign or domestic.

Taking the next step

Choosing between an C Corp and S Corp requires you to address several key questions:

Are you considering raising funds by issuing stocks?
Do you anticipate having investors from overseas or business entities?
How do you envision your shareholder pool now and in five years?
Is selling your company a part of your future plan?
Can your finances handle double taxation or, alternatively, increased IRS scrutiny?

The answers to these questions should guide you toward the most suitable choice for your business, whether that’s an S Corp or a C Corp. But don’t forget, these aren’t your only options. An LLC, partnership, or even a sole proprietorship might better align with your startup’s needs. Always keep your specific business goals in mind when making this decision.

C Corp vs. S Corp FAQ

How do I know if a company is a C Corp or an S Corp?

Consulting the company’s public records, such as its articles of incorporation or filing with the IRS, can help you determine whether a company is a C Corp or an S Corp. Alternatively, you can contact one of the company’s representatives and ask them to provide the necessary details.

What is the difference between an S Corp and a C Corp?

The key difference between an S Corp and a C Corp lies in ownership and taxation. In S Corps, profits and losses are passed through to shareholders’ personal tax returns. Meanwhile, C Corps are taxed separately from their owners and have potentially higher tax implications. Although a C Corp offers more flexibility, it is expensive to form and often subject to double taxation.

Which is better: an LLC or an S Corp?

When choosing a business structure, make sure to account for your individual goals and requirements. If flexibility is what you seek, LLCs offer just that. They allow for different ways to organize ownership, manage operations, and handle taxes. If avoiding excess taxation matters, S Corporations make a strong case. They help shareholders avoid double taxation and occasionally treat them to tax benefits. However, the ideal corp status ultimately depends on your specific business needs and objectives.

Which has lower taxes: a C Corp or an S Corp?

In general, C Corporations tend to pay more in taxes than S Corporations. S Corporations are pass-through entities, meaning their earnings are distributed to shareholders. These shareholders are then taxed at their personal income tax rate, which is typically lower than corporate income tax.