5 Reasons to Choose C Corp or S Corp for Your Business
If you are starting a business, one of the most important decisions you will have to make is what type of legal entity to form. There are many options, such as sole proprietorship, partnership, limited liability company (LLC), and corporation. However, if you decide to form a corporation, you will also have to choose between two subtypes: C corporation and S corporation.
What are the differences between C corp and S corp, and how can they affect your business? In this article, we will explain the main features, advantages, and disadvantages of each type of corporation, and help you decide which one is best for your situation.
C Corporation vs S Corporation: The Basics
A C corporation is the default type of corporation that is formed when you file articles of incorporation with your state. A C corporation is a separate legal entity from its owners (called shareholders), and it pays taxes on its income at the corporate level. A C corporation can have an unlimited number of shareholders, and they can be individuals or other entities. A C corporation can also issue different classes of stock, such as common stock and preferred stock.
An S corporation is a special type of corporation that elects to be taxed as a pass-through entity. This means that the S corporation does not pay taxes on its income at the corporate level, but rather passes it through to its shareholders, who report it on their personal income tax returns. An S corporation can only have up to 100 shareholders, and they must be individuals who are U.S. citizens or residents. An S corporation can only issue one class of stock.
C Corporation vs S Corporation: The Pros and Cons
Both C corp and S corp have some advantages and disadvantages that you should consider before choosing one for your business. Here are some of the main factors to compare:
– Taxation: The main difference between C corp and S corp is how they are taxed. A C corp pays taxes on its income twice: once at the corporate level, and again when the shareholders receive dividends. This is known as double taxation, and it can reduce the after-tax profits of the business. However, a C corp can also deduct certain expenses, such as employee benefits and salaries, from its taxable income, which can lower its tax burden. A C corp can also retain some of its earnings for future growth without paying taxes on them.
An S corp avoids double taxation by passing its income directly to its shareholders, who pay taxes on it at their individual tax rates. This can result in lower taxes for the business and its owners, especially if they are in lower tax brackets. However, an S corp cannot deduct certain expenses, such as health insurance premiums for shareholders who own more than 2% of the stock, from its taxable income. An S corp must also distribute all of its earnings to its shareholders every year, which can limit its ability to reinvest in the business.
– Liability: Both C corp and S corp provide limited liability protection for their shareholders, meaning that they are not personally responsible for the debts or obligations of the business. However, this protection is not absolute, and there are some situations where shareholders can be held liable, such as if they personally guarantee a loan for the business, or if they engage in fraud or negligence.
– Ownership: Another difference between C corp and S corp is how they are owned and managed. A C corp can have an unlimited number of shareholders, who can be individuals or other entities, such as other corporations or trusts. A C corp can also issue different classes of stock, which can have different voting rights and dividend preferences. This gives a C corp more flexibility in raising capital and attracting investors.
An S corp can only have up to 100 shareholders, who must be individuals who are U.S. citizens or residents. An S corp can only issue one class of stock, which means that all shareholders have equal voting rights and dividend rights. This limits the options for an S corp to raise funds and attract investors.
– Administration: Both C corp and S corp have to comply with certain rules and regulations at the state and federal levels. For example, both types of corporations have to file annual reports with their state authorities, pay filing fees, maintain corporate records, hold annual meetings, and follow corporate formalities. However, a C corp has more complex tax reporting requirements than an S corp. A C corp has to file a corporate income tax return (Form 1120) with the IRS every year, as well as quarterly estimated tax payments. A C corp may also have to file state corporate income tax returns and pay state corporate taxes.
An S corp has simpler tax reporting requirements than a C corp. An S corp does not file a corporate income tax return with the IRS or pay corporate taxes. Instead, an S corp files an information return (Form 1120S) with the IRS every year, which reports the income and expenses of the business, as well as the share of income and losses allocated to each shareholder. An S corp may also have to file state information returns and pay state taxes, depending on the state.
C Corporation vs S Corporation: Which One to Choose?
There is no definitive answer to which type of corporation is better for your business. It depends on your specific goals, needs, and preferences. However, here are some general guidelines to help you decide:
– Choose a C corp if you want to have more flexibility in ownership and management, raise capital from a large number of investors or different types of investors, issue different classes of stock, retain some of your earnings for future growth, or deduct certain expenses from your taxable income.
– Choose an S corp if you want to avoid double taxation, pay lower taxes on your business income, distribute all of your earnings to your shareholders every year, or simplify your tax reporting requirements.
However, before you make a final decision, you should consult with a tax professional and a legal expert who can advise you on the best option for your situation.
How C Corps and S Corps Differ: A Statistical Overview
C corps and S corps are two types of legal entities that can be formed by businesses in the United States. They have some similarities, such as limited liability protection for shareholders, but they also have some important differences, especially in terms of taxation and ownership. Here are some statistics that show how C corps and S corps differ and how they affect the global demand in this industry.
Taxation
One of the main differences between C corps and S corps is how they are taxed. C corps are subject to corporate tax rates on their income and distributions, and their owners or employees also pay tax on their income. This results in double taxation, which can reduce the net income of C corps. According to the IRS, the corporate tax rate for 2021 is 21%, and the individual income tax rates range from 10% to 37% depending on the income level.
S corps are pass-through entities that report their income, losses, deductions, and credits on the owners’ personal taxes, and do not pay corporate tax. This avoids double taxation and allows S corps to retain more of their profits. However, S corps also have to pay payroll taxes on salaries and wages paid to employees and shareholders who work for the business. According to the IRS, the payroll tax rate for 2021 is 15.3%, which consists of 12.4% for Social Security and 2.9% for Medicare.
Ownership
Another difference between C corps and S corps is the ownership structure and restrictions. C corps have no limitations on who can own shares, how many shareholders they can have, or how many classes of stock they can issue. This gives C corps more flexibility and options to raise capital from various sources, such as venture capitalists, angel investors, or public offerings. According to PitchBook, C corps accounted for 93% of all venture capital deals in the US in 2020.
S corps have more limitations on ownership, such as a limit of 100 shareholders, one class of stock, and only US citizens or residents as shareholders. This makes S corps less attractive for investors who want more control or diversity in their portfolio, or who are based outside the US. According to Statista, S corps accounted for only 13% of all corporations in the US in 2018.
Global Demand
The global demand for C corps and S corps depends on various factors, such as the size, industry, and goals of the business, as well as the tax laws and regulations of different countries. Generally speaking, C corps may have more advantages for large-scale businesses that operate internationally and need access to more capital and markets. S corps may have more advantages for small-scale businesses that operate domestically and want to save on taxes and retain more profits.
According to IBISWorld, the global corporate services industry, which includes services such as accounting, legal, consulting, and management for corporations, generated $1.6 trillion in revenue in 2020, with an annual growth rate of 0.9% from 2016 to 2021. The US accounted for 36% of this revenue, followed by Europe with 28%, Asia-Pacific with 25%, and other regions with 11%. The demand for corporate services is expected to increase as more businesses form corporations or expand their operations globally.
References:
http://corp.delaware.gov/Aug09feesch.pdf
https://www.irs.gov/pub/irs-pdf/i1120.pdf
https://www.irs.gov/businesses/small-businesses-self-employed/corporation-income-tax-brackets-and-rates
https://www.irs.gov/taxtopics/tc751
https://pitchbook.com/news/articles/why-are-so-many-startups-incorporating-as-c-corps
https://www.statista.com/statistics/194247/number-of-c-and-s-corporations-in-the-us-since-1980/
https://www.ibisworld.com/global/market-research-reports/global-corporate-service-industry/
https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations
https://www.irs.gov/businesses/small-businesses-self-employed/c-corporations
https://www.sba.gov/business-guide/launch-your-business/choose-business-structure
