When it comes to starting your own business there is a lot to consider. While we can’t help you decide on what you want to name your business, or whether you want to start a coffee shop or bar, we can provide some information to help you decide what legal structure to choose for your business. In this article we’ll be breaking down the difference between an S Corp vs C Corp, we’ll weigh up the pros and cons, and help you figure out what might be the best decision for you and your business.
Keep in mind, these are not the only types of business structure. If you’re interested in other business structures read our article on S Corp vs LLC. Structuring as a sole proprietorship is also a popular option for business owners just starting out.
C Corporation vs. S Corporation
Let’s start by breaking down what a C Corporation and an S Corporation actually are. Once you have a good understanding of the key elements of both business structures you’ll be able to better understand how one might benefit your business more than the other.
What Is a C Corp?
A C Corp is your standard-issue corporation. It is a separate taxpaying entity to the individual business owners. C Corps pay taxes as a business and the individual shareholders then pay extra taxes based on their personal income. If you do decide that a C Corp is the best structure for your business, it is important that you set up a separate bank account for your small business. This allows you to separate business from personal expenses come tax time. Not separating your expenses will cause headaches and could get you and your business in trouble.
Because registering as a C Corp means double taxation for the business owner, this business structure is eligible for special tax deductions.
To qualify for C Corp status your business must:
- Be owned by shareholders (there is no limit on shareholders)
- Have a board of directors (BOD) overseeing general operations
- Have officers (at least 2), which answer to the BOD
To register as a C Corp your business must:
- Choose a name
- File articles of incorporation with the secretary of state
- File taxes with IRS Form 1120
What Is an S Corp?
The purpose of registering as an S Corp is mainly to avoid double taxation. Now bear with us, because things are about to get a bit technical. As an S Corp you elect to be taxed under Subchapter S of Chapter 1 of the IRS’s Internal Revenue Code. All this means is that when the business makes money, it goes directly to the shareholders. The shareholders then have to file this income on their individual personal income tax.
To qualify as an S Corp your business must:
- Be a domestic corporation
- Have 100 shareholders or less
- Have one class of stock issued
- Be owned by shareholders (there is no limit on shareholders)
- Have a board of directors (BOD) overseeing general operations
- Have officers (at least 2) who answer to the BOD
To register as an S Corp your business must:
- First file as an LLC or C Corp within your state of operation
- Apply for S Corp status with the IRS by submitting Form 2553
- Make sure each individual shareholder signs this form
What Is the Difference Between an S Corp and a C Corp?
S Corps and C Corps actually have quite a lot in common, which is why most people don’t really know there is a difference. The biggest draw for business owners is that the S Corp and C Corp business structure both offer liability protection of the owners’ personal assets. This means that if something happens to your business, your personal assets (home, car, etc) will be protected.
In terms of how an S Corp and C corp operate as a business, they are pretty similar. Both business structures are owned by shareholders, overseen by a board of directors (BOD), and managed by officers that report to the BOD. The board of directors oversees the broader operations and strategies of the business like budgeting and allocating money. Meanwhile the officers manage day to day operations and act as a liaison between the business and board of directors
Both S Corps and C Corps have annual fees and are required to have annual meetings and bylaws.
So now we’ve covered the similarities between these two corporate structures, let’s breakdown the differences.
- Taxation:
The key difference between S Corps and C corps comes down to taxes. S Corps avoid double taxation. They are a pass-through entity, meaning shareholders receive their payout and file it as income on their personal tax return.
C Corps, on the other hand, are double-taxed. Once at the corporate level (business taxes) and again at the personal level (shareholders also file personal tax returns).
No matter the business structure it is vital you are making an effort to file your taxes correctly. Otherwise this could be the downfall of your business.
- Ownership:
Another difference between S Corps and C Corps is ownership. While there are tax advantages of structuring as an S Corp, the restrictions on ownership are slightly tighter. Here are the differences between S Corps and C Corps when it comes to ownership.
- S Corps
- Can have a maximum of 100 shareholders
- Can only be owned by US citizens or residents
- Can’t be owned by other corporations, LLCs, or other entities, only individuals
- C Corps
- Less limitations for ownership
- No limit to shareholders
- Can be owned by other legal entities
- No stipulations on whether it needs to be foreign or domestic
- Stocks:
Ok let’s talk stocks. Like with ownership S Corps are more restricted than C Corps when it comes to stock. This is an important distinction between the two structures because the class of stock (as well as the number of classes you can have) can have a big impact on the overall value of a company.
- S Corps are required to have only one class of stock.
- C Corps have little restrictions for stocks. They can have multiple classes of stocks.
Investors prefer to invest in businesses that are C Corps over S Corps because they can have multiple classes of stock and there is more room for growth and return on their investment.
With S Corps, there is one class of stock, meaning there is only one type of shareholder. Typically having multiple classes of stock provides a hierarchy between the shareholders. With S Corps, everyone is at the same level.
Whether you’re an S Corp or a C Corp your investors are going to want to see a comprehensive business structure before they make any decisions about your business. That’s why it is important to write a strong business plan.
Should Your Business Be an S Corp or a C Corp?
Now you have a clear idea of what each of these business structures are and how they are different, it’s time to break down the pros and cons so you can decide what’s right for your business.
Pros: Reasons to Become an S Corporation
Here are some reasons an S Corp might be the right choice for your business.
- No double taxation – S Corps don’t pay corporate income tax. Shareholders split up income and report it on a personal tax return.
- Deductions – Most S Corps can deduct 20% of business income on their personal return.
- Ability to write off business’s losses on your individual tax return- This is a benefit for new businesses operating at a loss for its initial years.
Cons: Limits of an S Corporation
- Cannot exceed 100 shareholders/owners
- Only one class of stock- This means you’ll have limited stock flexibility
- Costly to file and register as an S Corp
- Harder to form – should incorporate then elect S Corp status with additional paperwork through the IRS
Pros: Reasons to Become a C Corporation
- Easier to form than an S Corp – Because a C Corp is the default structure, you won’t need to file any additional paperwork or pay extra fees to file as one.
- Deductions– When your business is a C Corp, you can deduct the cost of fringe benefits (e.g., health insurance, disability) on a tax return.
- Charitable contributions are 100% deductible.
- Easier to raise money through additional investors because you can have multiple classes of stock
- No shareholder limit
Cons: Limits of a C Corporation
- Double taxation
- No personal write-offs – There is nothing that a shareholder can write off on their personal income tax return.
S Corporation vs. C Corporation: A Final Overview
Now that you’ve got all the facts, you’re in a good position to decide if an S Corp or a C Corp is the better option for you. If you’re happy for your business to only have one class of stock and no more than 100 owners and shareholders, all who are American citizens, you can consider filing as an S Corp. This will allow you to write off your businesses losses on your individual tax return which is very beneficial if you are operating at a loss during your first year.
If you want less restrictions in how your business is structured and to raise money through investors, a C Corporation might be the better option for you. Just be aware that you will also need to pay double taxation.
