When starting a business or changing your business structure, one of the most common options business owners evaluate is whether to form an S corporation (S-corp) or C-corporation (C-corp). These are the two most common ways to incorporate, and the choice really depends on your business goals.
S corporation vs. C corporation: The similarities
The C-corporation is the standard corporation, while the S-corporation has elected a special tax status with the IRS. It gets its name because it is defined in Subchapter S of the Internal Revenue Code. To elect S-corporation status when forming a corporation, Form 2553 must be filed with the IRS and all S corporation guidelines met. But C-corporations and S-corporations share many qualities:
- Limited liability protection. Both offer limited liability protection, so shareholders (owners) are typically not personally responsible for business debts and liabilities.
- Separate entities. Both the S-corp and C-corp are separate legal entities created by a state filing.
- Filing documents. Formation documents must be filed with the state. These documents, typically called the Articles of Incorporation or Certificate of Incorporation, are the same for both C and S corporations.
- Structure. Both have shareholders, directors and officers. Shareholders are the owners of the company and elect the board of directors, who in turn oversee and direct corporation affairs and decision-making but are not responsible for day-to-day operations. The directors elect the officers to manage daily business affairs.
- Corporate formalities. Both are required to follow the same internal and external corporate formalities and obligations, such as adopting bylaws, issuing stock, holding shareholder and director meetings, filing annual reports, and paying annual fees.
S corporation vs. C corporation: The differences
Despite their many similarities, S-corporations and C-corporations also have distinct differences.
- Taxation. Taxation is often considered the most significant difference for small business owners when evaluating S-corporations vs. C-corporations.
- C-corporations. C-corps are separately taxable entities. They file a corporate tax return (Form 1120) and pay taxes at the corporate level. They also face the possibility of double taxation if corporate income is distributed to business owners as dividends, which are considered personal income. Tax on corporate income is paid first at the corporate level and again at the individual level on dividends.
- Personal Income Taxes. With both types of corporations, personal income tax is due both on any salary drawn from the corporation and from any dividends received from the corporation.
- Corporate ownership. C-corporations have no restrictions on ownership, but S-corporations do. S-corps are restricted to no more than 100 shareholders, and shareholders must be US citizens/residents. S corporations cannot be owned by C-corporations, other S-corporations, LLCs, partnerships or many trusts. Also, S-corporations can have only one class of stock (disregarding voting rights), while C-corporations can have multiple classes. C-corporations therefore provide a little more flexibility when starting a business if you plan to grow, expand the ownership or sell your corporation.
Why choose a C-corporation?
When registering a company, C-corporation or C-corp is the most common corporation type, but it isn’t always the top choice for small business owners. C corporations provide limited liability protection to owners, who are called shareholders, meaning owners are typically not personally responsible for business debts and liabilities. Starting a C corporation may also offer greater tax advantages because of an expanded ability to deduct employee benefits, which are most often used by growing businesses.
Starting a C-corporation typically provides a number of advantages:
- Limited liability protection. Owners are not typically responsible for business debts and liabilities.
- Unlimited owners. C-corps can have an unlimited number of shareholders.
- Easy transfer of ownership. Ownership is easily transferable through the sale of stock.
- Unlimited life. When a C-corporation’s owner incurs a disabling illness or dies, the corporation does not cease to exist.
- Owners take reasonable salaries. Salaries paid to owners of C-Corporations, though taxable to them as salary, are deducted from C-Corp profits for income tax purposes.
- Owners are not automatically taxed on business earnings. In contrast to pass-through entities like LLCs, earnings of a C-Corporation are not automatically taxed to the owners. They are taxed to owners if distributed as dividends. The C-Corp pays tax on its income at C-Corp tax rates.
- Raise capital more easily. Additional capital can be raised by selling shares of stock.
- Retained earnings inside the business. A C-Corp could successfully retain earnings for reasonable business needs, if it complies with the accumulated earnings tax provisions, instead of distributing them to shareholders.
- Credibility. C-Corps may be perceived as a more professional/legitimate entity than a sole proprietorship or general partnership.
- Lower audit risk. Generally C-corporations are audited less frequently than sole proprietorships.
- Tax deductible expenses. Business expenses may be tax-deductible.
- Self-employment tax savings. A C-corporation can offer self-employment tax savings, since owners who work for the business are classified as employees.
How do you form a C-corporation?
In order to register a company as a C corporation, a Certificate of Incorporation, must be filed with the state and the necessary filing fees paid. Upon incorporation, C-corporations are also required to adopt bylaws, hold an initial meeting of directors and shareholders, and issue shares of stock to owners.
Are You Looking for a PC?
Professional services that require state licensing (doctors, lawyers, architects, etc.) may require forming as a Professional Corporation or PC.
C-Corp Key Benefits
C-corporations are more flexible than S-corporations in terms of the number of owners (shareholders) they can have and who can be an owner. That is one reason why C-corps are the business type of choice for venture capitalists when they provide funding to a business.
Keep in Mind
Corporations face the most extensive ongoing formalities of any business type. C-corporations must adopt and regularly update bylaws, hold and properly document annual meetings of directors and shareholders and more.
- C-corporation. A separate legal entity created by a state filing. The C-corporation, also called the “regular” corporation, is subject to corporate income tax. Income earned by a C-corporation is normally taxed at the corporate level using the corporate income tax rates. C-corporation income is also subject to what is called “double taxation,” when the income of the business is distributed to the owners in the form of dividends, because dividends are taxable. Tax is paid first by the corporation on its income and then again by the owners on the dividends received. If the owner draws a salary from the corporation, that salary is also subject to income tax (and FICA).