7 Differences Between C Corp and S Corp You Need to Know
If you are starting a business, one of the most important decisions you have to make is choosing the right type of corporation. There are two main types of corporations in the US: C corporation (C corp) and S corporation (S corp). Each one has its own advantages and disadvantages, depending on your business goals, tax situation, and ownership structure. 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 Corporation?
A C corporation is the most common type of corporation in the US. It is a separate legal entity from its owners, who are called shareholders. A C corporation can have an unlimited number of shareholders, who can be individuals or other entities. A C corporation is taxed as a separate entity, meaning that it pays corporate income tax on its profits, and then the shareholders pay personal income tax on the dividends they receive from the corporation. This is known as double taxation.
What is an S Corporation?
An S corporation is a special type of corporation that elects to be taxed as a pass-through entity. This means that it does not pay corporate income tax, but rather passes its income, losses, deductions, and credits to its shareholders, who report them on their personal tax returns. An S corporation can have up to 100 shareholders, who must be US citizens or residents. An S corporation cannot have other corporations or partnerships as shareholders. An S corporation can also avoid double taxation, since it does not pay corporate income tax.
What are the Differences Between C Corp and S Corp?
There are several differences between C corp and S corp that affect their taxation, ownership, management, and liability. Here are some of the main ones:
1. Taxation
As mentioned above, a C corp pays corporate income tax on its profits, and then the shareholders pay personal income tax on the dividends they receive from the corporation. An S corp does not pay corporate income tax, but passes its income and losses to its shareholders, who report them on their personal tax returns. This can result in lower taxes for an S corp, especially if the shareholders are in lower tax brackets than the corporation. However, an S corp may also have to pay state taxes, payroll taxes, and other taxes that a C corp does not.
2. Ownership
A C corp can have an unlimited number of shareholders, who can be individuals or other entities. A C corp can also issue different classes of stock, such as preferred stock or common 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 cannot have other corporations or partnerships as shareholders. An S corp can only issue one class of stock, with equal rights and preferences for all shareholders.
3. Management
A C corp is managed by a board of directors, who are elected by the shareholders. The board of directors appoints officers, such as the CEO, CFO, and COO, who run the day-to-day operations of the corporation. The shareholders have limited influence over the management decisions of the corporation, unless they own a majority of the shares or have special voting rights. An S corp is also managed by a board of directors and officers, but the shareholders have more control over the management decisions of the corporation, since they have equal voting rights and can elect or remove directors and officers.
4. Liability:
A C corp provides limited liability protection to its shareholders, meaning that they are not personally liable for the debts or obligations of the corporation. The only exception is if they engage in fraud or illegal activities that harm the corporation or its creditors. An S corp also provides limited liability protection to its shareholders, with the same exception as a C corp.
5. Flexibility
A C corp has more flexibility in terms of raising capital, issuing stock options, distributing profits, and planning for taxes. A C corp can raise capital from various sources, such as angel investors, venture capitalists, banks, or public markets. A C corp can also issue stock options to its employees or other parties as an incentive or compensation. A C corp can retain its profits for reinvestment or distribute them as dividends to its shareholders at its discretion. A C corp can also use various tax strategies to reduce its taxable income or defer its taxes. An S corp has less flexibility in these aspects, since it has to follow certain rules and restrictions imposed by the IRS and state laws.
6. Compliance
A C corp has more compliance requirements than an S corp in terms of filing reports, paying fees, and maintaining records. A C corp has to file annual reports with the state where it is incorporated and with the IRS. A C corp also has to pay annual fees to the state and federal governments for maintaining its corporate status. A C corp has to keep detailed records of its financial transactions,
operations, meetings, and resolutions. An S corp has fewer compliance requirements than a C corp, but it still has to file annual reports with the state and the IRS, pay annual fees to the state, and keep adequate records of its activities.
7. Conversion
A C corp can convert to an S corp by filing a form with the IRS and obtaining the consent of all its shareholders. However, a C corp may have to pay taxes on its built-in gains and passive income for 10 years after the conversion. An S corp can convert to a C corp by revoking its S election with the IRS and notifying its shareholders. However, an S corp may lose some of the tax benefits it enjoyed as an S corp after the conversion.
Which One is Better for Your Business?
There is no definitive answer to which type of corporation is better for your business, since it depends on various factors, such as your business goals, tax situation, ownership structure, and future plans. However, here are some general guidelines that may help you decide:
- Choose a C corp if you want to raise capital from various sources, issue different classes of stock, retain or distribute your profits at your discretion, use various tax strategies, or have more flexibility in your business operations.
- Choose an S corp if you want to avoid double taxation, have more control over your management decisions, have fewer compliance requirements, or have a simple ownership structure.
However, before you make a final decision, you should consult with a qualified accountant or attorney who can advise you on the best option for your specific situation.
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. There are many factors to consider, such as taxes, liability, ownership, and capital. Two of the most common types of corporations are C Corp and S Corp, which have different advantages and disadvantages depending on the business goals and needs.
According to the IRS, there were 1.7 million C corporations and 4.2 million S corporations in 2018, the latest year for which data is available. This shows that S corporations are more popular than C corporations among small and medium-sized businesses, as they offer some tax benefits and flexibility. However, C corporations are still preferred by large and publicly traded companies, as they allow for unlimited shareholders and multiple classes of stock.
The main difference between C Corp and S Corp is how they are taxed. C corporations are subject to double taxation, meaning that they pay corporate income tax on their profits and then shareholders pay personal income tax on dividends or capital gains. S corporations are pass-through entities, meaning that they do not pay corporate income tax and instead report their profits and losses on the owners’ personal tax returns.
The average effective tax rate for C corporations was 17.5% in 2018, while the average effective tax rate for S corporations was 26.9%. However, this does not account for the additional taxes that C corporation shareholders pay on dividends or capital gains, which can vary depending on their income level and filing status. Therefore, the total tax burden for C corporation owners may be higher than that for S corporation owners.
Another difference between C Corp and S Corp is the ownership structure. C corporations can have unlimited shareholders, both domestic and foreign, and can issue different classes of stock with different voting and dividend rights. S corporations can have up to 100 shareholders, who must be U.S. citizens or residents, and can only issue one class of stock. This limits the ability of S corporations to raise capital from outside investors or to create complex ownership arrangements.
The choice between C Corp and S Corp depends on various factors, such as the size, growth potential, profitability, and industry of the business. There is no one-size-fits-all answer, as each type of corporation has its pros and cons. Therefore, it is advisable to consult a professional accountant or attorney before making a decision.
References:
https://www.irs.gov/pub/irs-pdf/i1120.pdf
https://www.irs.gov/pub/irs-pdf/f2553.pdf
https://www.forbes.com/advisor/business/c-corp-vs-s-corp/
S-Corp vs. C-Corp: How They Differ (and How to Choose) – NerdWallet
C Corp vs S Corp – Meaning, Similarities & Differences – WallStreetMojo
Difference Between S Corp and C Corp (with Similarities and Comparison …
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
https://www.investopedia.com/ask/answers/09/difference-between-s-c-corporation.asp
https://www.legalzoom.com/articles/c-corp-vs-s-corp
