What is the Difference Between an S CORP and C CORP?
When choosing a business structure, entrepreneurs have several options.
Some opt for a Limited Liability Company (LLC), while others may choose to form an S Corporation or a C Corporation.
Here, we compare the advantages and disadvantages of S Corps and C Corps.
Even though their names differ by just one letter, there are important distinctions between the two.
What is a C Corp vs. and a S Corp?
Before diving into the differences, let's discuss the similarities between the two.
When forming a corporation at the state level, you file Articles of Incorporation (or, in some states, a Certificate of Incorporation) with the Secretary of State or another corporate registration authority.
The state does not differentiate whether you plan to operate as a C Corp or an S Corp; it simply recognizes the entity as a corporation.
Corporations are separate legal entities that offer liability protection. Generally, owners are not personally liable for the company's debts.
Both C Corps and S Corps must follow certain corporate formalities, such as issuing stock, adopting bylaws, appointing a registered agent, and holding shareholder meetings.
Most states require corporations to file an annual report or statement of information (some require biennial filings) and may require corporations to pay an annual (or biennial) filing fee.
Again, these basic requirements remain the same regardless of whether you choose S Corp status or remain a default C Corp.
S Corp vs C Corp Diferences
So, what sets them apart? The primary differences between S Corps and C Corps boil down to taxation and ownership.
First, an S Corp election is a tax designation. A corporation can choose to be taxed under Subchapter S of the Internal Revenue Code by filing IRS Form 2553.
When this happens, the company is recognized as an S Corporation. Otherwise, it will be taxed under Subchapter C of the IRS Code and will be treated as a C Corp.
Not all corporations can elect S Corp status; they must meet certain IRS requirements regarding the number and type of shareholders, as we?ll discuss shortly.
Taxation: C Corporations face double taxation: the corporation itself pays corporate income tax, and shareholders pay federal income tax on dividends. This is known as "double taxation."
S Corporations are considered "pass-through entities." The S Corp does not pay corporate tax; instead, shareholders report business income (and possibly losses) on their personal tax returns. There is no corporate tax.
Ownership: C Corps have no ownership restrictions. Anyone can be a shareholder, including other businesses and foreign entities. There is no limit on the number of owners.
S Corps, however, are limited to 100 shareholders, who must be individuals and U.S. citizens.
Another key distinction is that S Corporations can issue only one class of stock, whereas C Corporations can have multiple classes (such as preferred and common stock).
Tax Differences Between S Corp and C Corp
The biggest distinction between C Corps and S Corps is how they are taxed.
C Corporations pay taxes on their income at the corporate level, and shareholders pay taxes on dividends.
S Corporations do not pay income tax directly. Instead, they file IRS Form 1120S, an informational return that reports income and expenses to the IRS.
Profits or losses are reported on Schedule K-1, which shareholders include on their personal tax returns. Again, profits or losses flow through to individual shareholders.
S Corp Taxes
Tax benefits are among the biggest advantages of S Corporations. S Corp owners report business income and losses on their personal tax returns and can reduce their tax liabilities in various ways.
Business owners can take advantage of legally available tax deductions, such as home office deductions, mileage deductions, and more.
S Corp owners working in the business can lower payroll taxes by paying themselves a reasonable salary (subject to payroll taxes) and then receiving part of the income as distributions that are not subject to payroll taxes.
This can result in lower payroll taxes compared to, say, a sole proprietorship, where the owner must pay the full self-employment tax.
S Corp owners can deduct up to 20% of qualified business income (QBI) on their personal tax returns through the Qualified Business Income Deduction (QBI).
Not all income qualifies (e.g., salaries do not). Among eligibility requirements, taxable income in 2022 must be $170,050 or less for single filers or $340,100 for joint filers.
These limits increase in 2023 to $182,100 for single filers and $364,200 for joint filers. Partial deductions may be available above these limits, but the rules become more complex. QBI is available to sole proprietorships and partnerships but not to C Corp shareholders.
With an S Corp, you can deduct business losses on personal tax returns, subject to certain limitations.
C Corp Taxes
C Corporations file corporate tax returns and pay taxes on corporate profits.
Corporations have access to various business tax deductions, including salaries, healthcare benefits, retirement plan contributions, employee education expenses, and more.
However, C Corps cannot deduct dividends paid to shareholders, and C Corp shareholders do not have access to certain personal tax deductions available to owners of other business structures.
(For example, employees of a C Corp cannot deduct home office expenses, and shareholders cannot deduct corporate losses on personal tax returns.)
Ownership Differences Between S Copr and C Corp
S Corp Ownership
If you are comfortable with ownership restrictions, an S Corp may work for you.
Again, you can have up to 100 shareholders, who must be U.S. citizens. Corporations, trusts, and LLCs cannot own S Corps.
Only one class of stock is allowed.
C Corp Ownership
If you plan to sell your company in the future or seek venture capital funding, a C Corp is generally preferred.
You can have an unlimited number of shareholders, including other C Corps, S Corps, corporations, trusts, and foreign owners.
Multiple classes of stock are allowed, meaning some shareholders can have voting rights while others do not.
When Does It Make Sense to Be an S Corp?
S Corps are often popular among small business owners with high earnings who want to reduce their tax burden.
As mentioned earlier, owners can pay themselves a salary subject to payroll taxes while also receiving distributions that are not taxed as payroll income.
Additionally, S Corp owners can take advantage of various business tax deductions and deduct business losses.
Beyond the double taxation of a C Corp, tax preparation and filing can be more costly for a C Corporation.
Overall, an S Corporation is easier to form and maintain than a C Corporation. And when it comes to obtaining financing, there are still plenty of options as long as you meet lender requirements for business age and revenue.
More options to Consider
You may have other choices beyond an S Corp or C Corp. For example, if you plan to be the sole owner of your business, you may choose to operate as a sole proprietorship or a single-member LLC.
Additionally, you can form an LLC and elect to be taxed as an S Corporation, allowing you to reduce tax liabilities while avoiding some corporate formalities.
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It's also possible to start as an S Corp and later convert to a C Corp, though this requires additional paperwork and potential legal and accounting fees.