C Corp vs. S Corp
By Tim Kelly, J.D. | Legally reviewed by J.P. Finet, J.D. | Last reviewed May 22, 2024
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C corporations (C-corps) and S corporations (S-corps) are tax designations you can choose for your business entity. They are named after their subchapters in the U.S. Internal Revenue Code. Both types of corporation protect your assets from creditors and business debts. While they have similarities, there are a few critical differences that new business owners should know before choosing one for their enterprise.
The easiest way to tell a C-corp from an S-corp is its tax structure. The C-corp is subject to double taxation. First, companies pay a corporate income tax, 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 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 operation.
Both C-corps and S-corps carry a limited personal liability shield for owners. This is because corporations are separate entities from their owners. This is also why sole proprietors, who are viewed as the same entity as their business, cannot apply for C-corp or S-corp status.
The Key Difference: Taxation
The biggest difference between C-corps and S-corps is how they are taxed.
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, S-corps avoid double taxation. As an S-corp, any profits or losses pass through the company to the shareholders, who are then taxed at their personal income level.
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%. However, S-corps can write off 20% of their business income.
These subtle differences can make it difficult for small business owners to decide which structure is best. It's best to weigh the pro and cons of each against your business's structure and goals.
Differences in 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 their state, the Internal Revenue Service (IRS) will recognize them 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-corps, 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-corps 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, 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.
Which Kind of Owner Are You?
You've weighed the pros and cons of C-corps or 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. 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-corps shareholders must be U.S. citizens. The restrictions on ownership also attract shareholders seeking more input and visibility than offered by C-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.
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