C Corp vs. S Corp: What's the Best Option?

How Can You Tell a C Corp From an S Corp?

The easiest way to tell a C-corp from an S-corp is its tax structure. A C-corp is subject to double taxation. First, companies pay a corporate income tax on business income, and then owners are taxed again at the personal income level on dividend payments.

S-corps do not pay a tax at the corporate level. Instead, the owners or shareholders report any company profits at the personal income level. This is similar to how partnerships and limited liability partnerships (LLPs) are taxed.

C-corps and S-corps also differ in some of the ways they are owned and operated.

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Similarities Between C-Corps and S-Corps

To understand how they are different, it’s best to start with how C-corps and S-corps are similar.

Both corporate designations feature formalities such as requiring articles of incorporation and establishing a board of directors. Both types must also adopt bylaws, issue stock, and file yearly reports with the state. Owners are called shareholders, and they must hire directors to manage the company’s operations.

Both C-corps and S-corps carry a limited personal liability shield for owners. This is because corporations are separate entities from their owners. Their personal assets are protected from business debts and lawsuits.

The Key Differences: Taxation and Formation

The biggest difference between C-corps and S-corps is how they are taxed and set up.

Taxation

C-corps are subject to double taxation. Here, a company’s profits are taxed first at the corporate level and again at the personal income level. This means that any profits (or dividends) allotted to shareholders can be taxed again on their personal income tax returns.

On the other hand, there are tax advantages for S-corps because they avoid double taxation. With an S corporation status, any profits or losses pass through the company to the shareholders, who are then taxed at their personal income tax rate.

While S-corps have been favored business structures because they do away with the double tax, the 2017 tax bill made important changes. C-corps now have a flat corporate tax rate of 21%.

These subtle differences can make it difficult for small business owners to decide which structure is best. It’s best to weigh the pros and cons of each against your business’s structure and goals.

Formation

C-corps are the default tax designation for corporations. Thus, they are easier to form than S-corps. If a company files articles of incorporation in its state, the Internal Revenue Service (IRS) will recognize it as a C-corporation unless the company elects otherwise. There is no limit to the number of shareholders a C-corp can have.

To shift their status to an S-corp, companies must fill out IRS Form 2553. Businesses can make this change any time so long as they meet the requirements. Note that the criteria for filing as an S-corp are more strict. A company seeking S-corp status must:

• Have no more than 100 shareholders

• Be a domestic corporation

• Have allowable shareholders (limited to United States citizens or residents, certain trusts, and estates)

• Have only one class of stock

• Not be an ineligible corporation such as an insurance company

A cap on shareholders places a structural limitation on an S-corp. This makes it appealing to small business owners who want to incorporate the views of their shareholders. On the flip side, a C-corp will appeal to business owners seeking to grow their number of shareholders.

Once the IRS notifies the taxpayer of the S-corp acceptance, the corporation can pass through the profits or losses to the individual shareholders for them to include on their personal returns when they file taxes.

Comparison of C Corporation and S Corporations

Which Corporate Structure Is Best: C Corps or S Corps?

You’ve weighed the pros and cons of C-corps and S-corps, but the final step is deciding which kind of business owner you want to be. Again, your vision for the business will go a long way in determining which designation is right for you.

C-corps are appealing to business owners seeking expansion and acquisition. Unlike S-corps, C-corps have no restrictions on ownership. A C-corp can have as many owners as it likes. Moreover, those owners are not required to be U.S. citizens or residents. Other companies can even own C-corps.

Business owners who want to operate a smaller company and field input from their shareholders should opt for an S-corp. S-corp shareholders must be U.S. citizens. The restrictions on ownership also attract shareholders seeking more input and visibility than offered by C-corps.

A Note About Limited Liability Companies (LLCs)

LLCs are a legal entity that provides limited liability protection and, as a pass-through entity, offers the tax benefit of avoiding double taxation. LLCs are ideal for a sole proprietor looking for personal legal protection and pass-through taxation. Entrepreneurs favor LLCs as they are easy to form and there are fewer formalities than corporations (either C-corps or S-corps).

Weigh Your Options and Start Your Business

Deciding between a C-corp and an S-corp is challenging. A local small business lawyer can help you weigh your options. When you are ready to set up your business, consider an easy-to-use, reputable DIY business formation service.

Related Topics

• Tax Differences Between C-Corporations and S-Corporations
• Business Structures: Which One is Best for Your Business
• Corporations
• LLCs
• Sole Proprietorships: Paying Self-Employment Taxes