An Overview: S-Corp vs C-Corp
The distinctions between an S-corp and a C-corp lie in how they are founded, taxed, and in their ownership limits.
A C-corp is taxed at the corporate rate. And does not have limitations on ownership. In contrast, S-corp must be formed explicitly. Taxes are passed through and reported on the owner's taxes. Plus, ownership is limited to up to 100 shareholders.
What Are The Differences Between An S-Corp Vs C-Corp?
The distinctions between S-corporations and C-corporations may be divided into three primary categories including creation, taxes and ownership.
Let's delve a bit more into the distinctions between S-corps and C corporations since they will ultimately have the most influence on your company's bottom line.
The most fundamental distinction between S-corporations and C-corporations is how they are formed.
To incorporate your business as an S-corp, you must submit IRS Form 2553. After submitting the form, you will be classified as an S-corporation for federal tax reasons.
To be recognized as an S-corp for state taxes you may need to complete additional paperwork at the state level.
The C-corporation is the most common kind of corporation. When you submit articles of incorporation with your secretary of state to register your firm as a corporation it will become a normal C-corp.
Whether you structure your business as an S-corp or a C-corp you'll need to go through some of the same stages for corporate formation.
Articles of incorporation must be filed, a registered agent must be appointed and corporate bylaws must be created.
If corporate revenue is transferred to the corporation's shareholders as dividends the C-corp can be taxed again on the owners' income tax returns.
The legislation gives a significant tax break for C-corps. But you can't avoid double taxation as a C-corp. The corporation will be taxed at the corporate tax rate of 21%. And dividends will be taxed on personal income tax returns.
If your company is in its early stages of development and you want to reinvest the majority of its income then C-corp taxes may be advantageous.
An S-corp is a pass-through corporation for tax purposes. This means that shareholders record their portion of the business's revenue and losses on their tax returns.
Owners must pay taxes just once on their income tax rate and they are not subject to a corporation tax.
Owners of S-corporations and other pass-through companies can also deduct 20% of eligible company income on their tax returns. Unless Congress extends the statute, this deduction will expire in 2025.
Businesses in specialized service trades or professions at high-income levels such as consulting, medical, or law suffer deduction restrictions.
The only way to tell if an S-corp vs C-corp form is preferable from a tax aspect is to do the figures for your company. Based on predicted income for this year and future years.
Your accountant or company attorney will assist you in determining the structure that is most beneficial to your bottom line.
The constraints on corporate ownership are the final key distinction between S-corp and C-corp forms. If you want to expand your firm or sell it to another company then C-corporations provide you with a little more leeway.
What Similarities Are There Between S-Corp vs C-Corp?
The similarities between an S-corp and a C-corp will help you better understand each of these entity kinds. And why would you want to create a corporation rather than another sort of business company.
Their commonalities may be summed up as follows:
Although the shareholders of an S-corporation or C-corporation control the company they do not make the majority of the decisions.
Management and policy decisions are made by the company's board of directors chosen by shareholders. And the officials of the corporation are in charge of the day-to-day operations of the firm.
Because S-corps and C-corps are legal entities apart from their owners their shareholders have limited liability protection.
Simply put stockholders are not individually accountable for the company's debts or commitments. This is a significant selling feature for a company.
As previously stated, if you structure your company as an S-corp or C-corp then you'll need to go through the corporate formation process.
You must complete and submit the necessary incorporation forms, file articles of incorporation, designate a registered agent and draft company bylaws.
Corporations are required to satisfy specific paperwork and compliance standards such as issuing stock, paying fees and conducting shareholder as well as director meetings in contrast to other entity forms.
How To Decide Between S-Corporation vs C-Corporation
One may find many of the advantages and cons of both organizations in the three differences we just mentioned.
Here's another look at the benefits and drawbacks of S-corporations versus C-corporations.
Benefits Of S-Corp
Pass Through Taxation: The tax structure is without a doubt its most significant advantage. S-corps are exempt from paying taxes on company income twice. For small firms avoiding double taxes is a major benefit.
Deduction for company income: Under current legislation owners of most S-corps and other pass-through businesses can deduct 20% of their business income on their tax returns. This corporate tax deduction has the potential to lower your tax burden drastically.
Tax filing requirements: S-corporation owners can deduct their business losses from their tax filings.
This is advantageous for newer firms. As they are likely to operate at a loss in their first few years. As the owner you can deduct the business's losses from your income tax returns to balance your income from other sources.
Disadvantages Of An S-Corp
It is more difficult to establish: To elect S-corporation status you must file Form 2553 with the IRS and maybe extra state documentation. You must also follow any limits to keep your S-corp status and avoid penalties.
Ownership is restricted: Unlike C-corps even S-corps have a fixed limit on the number of shareholders they can accept. It is up to 100. Furthermore, stockholders must be legal residents of the United States. This is a challenge for high-growth companies or companies who want to conduct business globally.
Limited stock flexibility: S-corps also prohibits the issuance of preferred stock and multiple stock classes. Making it difficult to acquire funds from investors and motivate early owners.
Benefits Of A C-Corporation
Forming is easier: There is no additional paperwork to do because the C-corp is the default kind of corporation.
Employee fringe benefits: C-corporations can deduct the expense of employee fringe benefits such as disability and health insurance.
Shareholders of a C-corporation do not have to pay taxes on their fringe benefits if 70 percent of the firm obtains the same advantages.
Charitable contributions: A C-corporation is the only form of business company that may deduct 100% of charitable contributions. The gifts cannot exceed 10% of the entire revenue of the firm.
Disadvantages of a C-Corporation
Taxation twice: C-corps may pay higher taxes due to double taxation. If the company's revenue is dispersed as shareholder dividends it will be taxed at the corporate and personal levels.
There are no personal write-offs: Another tax disadvantage is that owners cannot deduct the business's losses from their income tax returns therefore balancing income from other sources.
How To Set Up Your Business As An S-Corp Or C-Corp
Finally, the stages differ slightly depending on the state in which your firm operates. In most situations you'll start by deciding on a name for your company and completing articles of incorporation.
You'll also need to write corporation bylaws, convene your first board of directors meeting and distribute stock certificates to stockholders.
Having said that if you're handling things yourself then online legal firms like LegalZoom and IncFile make it quick and easy to file incorporation forms.
However, you should ideally engage a lawyer to assist you in forming your organization.
The Bottom Line
Now that you know the distinctions between an S-corp vs. C-corp along with their pros and cons you're well equipped to make a sensible option for your firm.
Before deciding on an S-corp or C-corp structure don't forget to investigate other forms of corporate structures.
It's crucial to remember that the way you structure your small business is a huge choice with big consequences for your future.
If you are unsure about selecting a business entity or properly establishing your firm then consult a small business lawyer or accountant.