7 Differences Between C Corp and S Corp You Need to Know
If you are planning to start a business or incorporate an existing one, you may be wondering what are the differences between C corp and S corp. These are two of the most common types of corporations in the US, and they have different advantages and disadvantages for taxes, ownership, liability, and management. In this article, we will explain the main differences between C corp and S corp and help you decide which one is best for your business.
What is a C Corp?
A C corp, or C corporation, is a legal entity that is separate from its owners, also known as shareholders. A C corp can have an unlimited number of shareholders, who can be individuals or other entities. A C corp is taxed as a separate entity, meaning that it pays corporate income tax on its profits. The shareholders also pay personal income tax on any dividends they receive from the C corp, creating a double taxation situation.
A C corp has more flexibility in raising capital, as it can issue different types of stocks and bonds to investors. A C corp also has more protection from personal liability, as the shareholders are not responsible for the debts or obligations of the corporation. However, a C corp also has more regulations and compliance requirements, such as filing annual reports, holding board meetings, and keeping records of corporate decisions.
What is an S Corp?
An S corp, or S corporation, is a special type of corporation that elects to be taxed as a pass-through entity. This means that the S corp does not pay corporate income tax on its profits. Instead, the profits are passed through to the shareholders, who report them on their personal income tax returns. This avoids the double taxation issue that C corps face.
An S corp can have up to 100 shareholders, who must be US citizens or residents. An S corp can only issue one class of stock, which limits its ability to raise capital from different sources. An S corp also has less protection from personal liability, as the shareholders may be held liable for the debts or obligations of the corporation in some cases. However, an S corp also has less regulations and compliance requirements than a C corp, making it easier to manage and operate.
7 Differences Between C Corp and S Corp
Here are some of the key differences between C corp and S corp that you need to know before choosing one for your business:
1. Taxation: As mentioned above, a C corp pays corporate income tax on its profits, while an S corp does not. However, this also means that a C corp can deduct certain expenses that an S corp cannot, such as employee benefits and salaries. A C corp may also qualify for certain tax credits and incentives that an S corp does not.
2. Dividends: A C corp can distribute dividends to its shareholders at any time and at any amount, as long as it has enough retained earnings. A C corp can also retain some of its profits for future growth or investment. An S corp must distribute all of its profits to its shareholders at the end of each year, regardless of its financial situation. An S corp cannot retain any profits for future use.
3. Ownership: A C corp can have an unlimited number of shareholders, who can be individuals or other entities. A C corp can also have different classes of stock with different voting rights and dividend preferences. An S corp can have up to 100 shareholders, who must be US citizens or residents. An S corp can only have one class of stock with equal rights and preferences.
4. Liability: A C corp provides more protection from personal liability for its shareholders, as they are not responsible for the debts or obligations of the corporation. However, this does not mean that they are completely immune from lawsuits or claims. A shareholder may still be held liable if they act fraudulently or negligently in their role as a shareholder or director. An S corp provides less protection from personal liability for its shareholders, as they may be held liable for the debts or obligations of the corporation in some cases. This may happen if they personally guarantee a loan or contract for the corporation, or if they commingle their personal and business assets.
5. Management: A C corp has a more formal and complex management structure than an S corp. A C corp must have a board of directors that oversees the major decisions and policies of the corporation. The board of directors appoints officers who manage the day-to-day operations of the corporation. The shareholders elect the board of directors and vote on important matters such as mergers, acquisitions, or amendments to the bylaws. An S corp has a simpler management structure than a C corp. An S corp does not need to have a board of directors or officers unless required by state law or its own bylaws. The shareholders manage the corporation directly or delegate some authority to managers or employees.
6. Transferability: A C corp can easily transfer its shares to anyone without affecting its tax status or legal existence. A C corp can also sell or merge with another entity without the consent of all its shareholders, unless otherwise specified in its bylaws or shareholders’ agreement. An S corp can transfer its shares to anyone who meets the eligibility requirements for being an S corp shareholder. However, if an S corp transfers more than 50% of its shares within a 12-month period, it may lose its S corp status and revert to a C corp. An S corp also needs the consent of all its shareholders to sell or merge with another entity.
7. Formation: A C corp and an S corp are both formed by filing articles of incorporation with the state where they want to operate. They also need to adopt bylaws that govern their internal affairs and operations. However, an S corp also needs to file Form 2553 with the IRS within 75 days of its formation or within 75 days of the beginning of the tax year in which it wants to be treated as an S corp. This form elects the corporation to be taxed as a pass-through entity and confirms that it meets the eligibility requirements for being an S corp.
C Corp vs S Corp: A Statistical Comparison
One of the most important decisions that a business owner has to make is choosing the right legal structure for their company. Among the various options, corporations are popular because they offer limited liability protection and credibility. However, not all corporations are the same. There are two main types of corporations: C corp and S corp. These differ in terms of taxation, ownership, and capital raising.
Taxation: The Double Taxation Dilemma
The biggest difference between C corp and S corp is how they are taxed. C corp is taxed as a separate entity at the corporate level, and then the shareholders are taxed again on their dividends at the individual level. This is known as double taxation, and it can reduce the net income available to the owners. According to the IRS, the corporate tax rate for 2020 ranged from 15% to 35%, depending on the taxable income of the corporation.
S corp, on the other hand, is a pass-through entity that avoids double taxation. The profits and losses of S corp are reported on the owners’ personal tax returns, and they pay taxes at their individual tax rates. This can result in lower taxes for S corp owners, especially if they are in a lower tax bracket than the corporate tax rate. However, S corp owners may also have to pay self-employment taxes on their share of the profits.
Ownership: The Shareholder Limitations
Another difference between C corp and S corp is the number and type of shareholders they can have. C corp can have unlimited shareholders, which makes it easier to raise capital and expand the business. C corp can also issue different classes of stock, such as common stock and preferred stock, to attract different types of investors. C corp can also have foreign shareholders, which opens up more opportunities for international business.
S corp, however, can only have up to 100 shareholders, which limits its growth potential and access to capital. S corp can only issue one class of stock, which means that all shareholders have equal rights and preferences. S corp also has to meet certain eligibility criteria for its shareholders, such as being U.S. citizens or residents, and not being corporations, partnerships, or trusts.
Capital Raising: The Venture Capital Advantage
The third difference between C corp and S corp is their ability to raise capital from external sources, such as venture capitalists or angel investors. C corp has an advantage in this area because it can offer more incentives and flexibility to potential investors. For example, C corp can issue preferred stock that gives investors priority over common shareholders in terms of dividends and liquidation rights. C corp can also offer stock options or warrants that allow investors to buy more shares at a lower price in the future.
S corp, on the other hand, has a disadvantage in raising capital because it has fewer options and restrictions on its shareholders. For instance, S corp cannot issue preferred stock or other types of equity instruments that give investors special rights or benefits. S corp also cannot have more than 100 shareholders or foreign shareholders, which reduces its pool of potential investors.
The choice between C corp and S corp depends on your business goals, tax situation, and growth plans. If you want to minimize your taxes, keep your ownership simple, and avoid corporate formalities, then S corp may be a good option for you. However, if you want to maximize your growth potential, attract more investors, and have more flexibility in your ownership structure, then C corp may be a better option for you.
References:
http://corp.delaware.gov/Aug09feesch.pdf
https://www.irs.gov/pub/irs-pdf/p542.pdf
https://www.nerdwallet.com/article/small-business/s-corp-vs-c-corp
https://www.forbes.com/advisor/business/c-corp-vs-s-corp/
https://www.wallstreetmojo.com/c-corp-vs-s-corp/
https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations
https://www.sba.gov/business-guide/launch-your-business/choose-business-structure
https://www.investopedia.com/ask/answers/042215/what-difference-between-c-corporation-s-corporation.asp
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