Are you torn between the choice of registering a C Corp or S Corp? If YES, here are differences and similarities between C Corporation and S Corp. Firstly, it is important to state that under IRS rules, the C corporation is the standard (or default) corporation. The S corporation is a corporation that has elected a special tax status with the IRS and therefore has some tax advantages.
Both business structures get their names from the parts of the Internal Revenue Code that they are taxed under. C corporations are taxed under Subchapter C while S corporations are taxed under Subchapter S. To elect S corporation status when forming a corporation, Form 2553 must be filed with the IRS and all S corporation guidelines met. Here are some of the similarities shared by both C corporations and S corporations:
The Similarities Between S Corporation and C Corporation:
Table of Content
- a. Limited liability protection
- b. Separate legal entities
- c. Filing documents
- d. Structure
- e. Corporate formalities
- 1. Taxation
- 2. S corporations
- 3. Personal income taxes
- 4. Corporate ownership
- 5. Shareholder restrictions
- Advantages of a S Corporation
- Disadvantages of a S Corporation
- Other shareholder restrictions
- Transfer Restrictions
- Advantages of C Corporation
- Disadvantages of a C Corporation
a. Limited liability protection
Corporations offer limited liability protection, so shareholders (owners) are typically not personally responsible for business debts and liabilities. This is true whether it is taxed as a C corporation or an S corporation.
b. Separate legal entities
Corporations (C corps and S corps) are separate legal entities created by a state filing.
c. Filing documents
Formation documents must be filed with the state. These documents, typically called the Articles of Incorporation or Certificate of Incorporation, are the same regardless of whether you choose to be taxed as an S corporation or C corporation.
S corps and C corps have shareholders, directors and officers. Shareholders are the owners of the corporation, but it is the corporation that owns the business. The shareholders elect the board of directors. The board oversees and directs corporation affairs and decision-making but is not responsible for day-to-day operations. The board elects the officers to manage daily business affairs.
e. Corporate formalities
The state corporation laws make no distinction between C corporations and S corporations when it comes to compliance responsibilities. All corporations are required to follow the internal and external corporate formalities and obligations, such as adopting bylaws, issuing stock, holding shareholder and director meetings, maintaining a registered agent and registered office, filing annual reports, and paying annual fees.
The Differences Between S Corporation and C Corporation:
For small business owners evaluating S corporations vs. C corporations, the decision usually boils down to how they want the corporation to be treated for federal income tax purposes.
C corporations: C corps are separately taxable entities. They file a corporate tax return (Form 1120) and pay taxes at the corporate level. They also face the possibility of double taxation if corporate income is distributed to business owners as dividends, which are considered personal taxable income. Corporate income tax is paid first at the corporate level and again at the individual level on dividends.
2. S corporations
S corps are pass-through taxation entities. They file an informational federal return (Form 1120S), but no income tax is paid at the corporate level. The profits/losses of the business are instead “passed-through” to the business and reported on the owners’ personal tax returns. Any tax due is paid at the individual level by the owners.
3. Personal income taxes
With both C corporations and S corporations, personal income tax is due both on any salary drawn from the corporation and from any dividends received from the corporation.
4. Corporate ownership
As stated earlier on, state corporation laws make no distinction between S corporations and C corporations. But the Internal Revenue Code does place several restrictions on who can be shareholders in order for the corporation to qualify to be an S corp.
S corps are restricted to no more than 100 shareholders, and shareholders must be US citizens/residents. C corporations have no restrictions on ownership.
6. Ownership: S corporations cannot be owned by C corporations, other S corporations (with some exceptions), LLCs, partnerships or many trusts.
7. Stock: S corporations can have only one class of stock (disregarding voting rights), while C corporations can have multiple classes.
Advantages of a S Corporation
Single layer of taxation:
- The major advantage of the S corporations over the C corporations is that an S corporation does not pay a corporate-level income tax. In essence, any distribution of income to the shareholders is only taxed at the individual level.
- 20 percent qualified business income deduction
- The Tax Cuts and Jobs Act of 2017 gave eligible S corporations shareholders a deduction of up to 20 percent of net “qualified business income”.
- Pass-through of losses
- The losses of an S corporations pass-through to its shareholders, who can use the losses to offset income (subject to restrictions of the tax law).
Disadvantages of a S Corporation
- Limited number of shareholders
- An S corporation cannot have more than 100 shareholders, meaning it can’t go public and limiting its ability to raise capital from new investors.
- Shareholders must be individuals (with a few exceptions) and U.S. citizens or residents. This also makes it harder for an S corporation to obtain equity financing, particularly because venture capital and private equity funds tend to be ineligible shareholders.
- Preferred stock not allowed
- To be eligible for S corporation status the corporation cannot have different classes of stock. Some investors want preferences to distributions or other privileges. An S corporation cannot provide that.
Most S corps will restrict their shareholders’ ability to sell or transfer their shares. That’s to make sure they don’t end up with an ineligible shareholder which will cause the IRS to terminate its S corporation status. This makes it harder for the shareholders of an S corporation to exit the corporation.
Advantages of C Corporation
- Unlimited number of shareholders
- There is no limit on the number of shareholders a corporation taxed under Subchapter C can have.
- No restrictions on ownership
- Anyone can own shares, including business entities and non-U.S. citizens.
- No restrictions on classes
- A C corporation can issue more than one class of stock, including stock with preferences to dividends and distributions.
- Lower maximum tax rate
The 2017 tax reform act lowered the corporate tax rate to a flat 21 percent and eliminated the alternative minimum tax. Even with the personal income tax rates being slightly lowered, this rate is lower than the maximum personal tax rate (which is currently 37 percent).
More options for raising capital
Because Subchapter C of the tax code does not impose the same restrictions on ownership as Subchapter S, it is easier for a C corporation to obtain equity financing.
Disadvantages of a C Corporation
- Double taxation
The main disadvantage of the C corporation is that it pays tax on its earnings and the shareholders pay tax on dividends, meaning the corporation’s earnings are taxed twice.
In as much as it is now legal for a C Corporation to own an S Corporation, it is very important that you weigh your options before making this decision.