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The main difference when looking at S corporations versus C corporations is how these business entities are taxed.
C-corps pay taxes as a business when profits are earned, and then as a shareholder when dividends are paid out. S-corps avoid double taxation by allowing owners to pass income, losses, deductions and credits through the corporation to shareholders, who are taxed at individual income rates. There are also differences when it comes to corporate ownership.
S corporations and C corporations provide their own set of benefits and drawbacks. To help you decide on S-corps versus C-corps, we’ll give you a rundown.
What's an S-corp?
S corporations combine the legal protections of a C corporation with the tax benefits of a partnership. S-corps avoid double taxation. When the business makes money, it goes to the shareholders. S-corps shareholders are treated like employees, so they pay federal taxes on income and losses at the individual tax level. Any retained earnings or money that is reinvested into the business is still taxed.
For example, two owners create an S-corp for their business (Smith Enterprises). Each hold a 50% share in the company. The company reports $100,000 in profits its first year. In this case, both shareholders would be taxed on $50,000 in earnings. Looking at 2019 tax brackets, each owner — if filing as single — would pay an estimated $6,859 in taxes. The second year, the company earns $250,000 in net profits. This year, both owners decide to reinvest $25,000 each in the business. Despite reinvesting a total of $50,000, they will still each pay personal taxes on $125,000.
S-corps benefit from the limited liability a corporation offers, meaning creditors can’t come after shareholders’ personal property to pay business debts. S-corps are also eligible to receive tax breaks on health insurance and dental premiums.
To qualify as an S-corp, the business must:
- Be a domestic corporation
- Have no more than 100 shareholders
- Issue only one class of stock
- Have only allowable shareholders; partnerships, corporations, or non-resident alien shareholders are not eligible
- Not be an ineligible corporation; certain financial institutions, insurance companies and domestic international sales companies are not eligible to file as an S-corp
To set up an S-corp, you must first create a limited liability corporation (LLC) or C corporation within the state you’ll be operating. Once the business is created, you can then file for S-corp status with the IRS. This is done by submitting Form 2553 and having all the shareholders sign.
What's a C-corp?
A C-corporation is a separate taxpaying entity. When the corporation has a profit or loss, it pays taxes as a business. Any remaining profits can be distributed as dividends to shareholders or held by the corporation as retained earnings. However, when receiving dividends, shareholders are taxed again at individual income rates, creating a double tax.
To illustrate how this double tax might work, let’s consider Smith Enterprises from above. The company has two owners, each with a 50% stake in the company. The first year, they net $100,000 in profits. As a C-corp, this money would be subject to the current corporate tax rate of 21%, leaving them with $79,000 to receive as dividends. When owners receive their share of dividends, they’ll be taxed at their personal rate. In this case, each owner’s share of $39,500 — if filing a single — would be taxed at an estimated $4,549, or about $2,000 less than the individual S-corp owners above.
C-corps are eligible for special deductions on expenses relating to personnel, rental expenses and more. However, paying out dividends to shareholders cannot be claimed as a deduction, nor can shareholders deduct any losses from the corporation on their tax returns. C-corps receive all the same legal protections as S-corps, but they can also raise investment capital and take the company public. They are also not limited by the number of shareholders investing in the business. This makes C-corps a popular structure for businesses looking to grow rapidly or scale the business.
To structure your business as a C-corp, you must first choose a name and file articles of incorporation with your state’s secretary of state. When it comes time to file taxes, C-corps must file with IRS Form 1120. Owners may also be liable to pay estimated taxes, employment taxes, and excise taxes quarterly. S-corps have the option to file annually.
S-corp vs. C-corp
If you’re considering S corporations versus C corporations, one of the biggest differences — beyond how these businesses are taxed — is ownership.
S-corps are limited when it comes to ownership and stock options. They can have a maximum of 100 shareholders, may only issue one class of common stock and may not have shareholders who operate as partnerships or corporations. This eliminates big investors such as venture capitalist funds.
C-corps don’t have limitations when it comes to the number or type of shareholders. C-corps can issue both common and preferred stock, making them more attractive to outside investment.
Creating an S-corp or C-corp involves mostly the same process. But S corporations must file Form 2553 with the IRS to establish their status. This form must be signed by all the company’s shareholders.
How to choose the right business structure
When deciding between an S-corp or C-corp, you should consider both the short-term and long-term implications it may have on your business, since changing business structures later can result in fees and added taxes.
While S-corps and C-corps share similarities in how they are structured, both come with their own advantages and disadvantages when it comes to taxation and ownership.
- Avoid double taxation: By electing to have funds pass through the business entity, S-corp owners and shareholders are not taxed as a corporation and pay taxes at the individual level.
- Limited liability: S-corp owners and shareholders cannot be personally liable for the collection of business debts.
- Perpetuity: As an S-corp, the business can continue if an owner dies or leaves the company.
- Tax write-offs: S-corps benefit from deductions, including FICA payroll taxes, insurance premiums and more. Shareholders can also claim losses on their taxes.
- Greater restrictions on ownership: S-corps can only be created by U.S. citizens and permanent residents, meaning immigrant-owned businesses cannot structure as an S-corp. They are also limited to 100 shareholders in the business.
- Stock limitations: While C-corps allow owners to sell off common and preferred stock, S-corps are limited to only common stock. Additionally, shareholders cannot be corporations, partnerships or LLCs, which can hinder the business if looking for investment from a venture capital fund.
- S-corps cannot go public: This is due to the 100-shareholder limit. The company could go public, but the business would first have to restructure as a C-corp, which can have tax implications.
- Additional expenses: There are additional expenses that come with forming an S-corp. These include filing articles of incorporation, annual fees relating to annual reports and/or franchise fees.
- Ownership and shareholders: You do not have to be a U.S. citizen or permanent resident to create a C-corp. Also, there are no limits when it comes to the number or type of shareholders (individual versus partnership versus corporate) in the business. This makes them ideal for companies looking to attract investors and/or grow rapidly.
- Limited liability: Similar to S-corps, owners cannot be held personally responsible for debts the corporation incurs.
- Tax flexibility: C corps have greater flexibility when it comes to taxes since their fiscal year is not confined to the calendar year. Owners can decide when to claim profits versus losses, deduct payroll taxes and salaries and write off 100% of their health care premiums and fringe benefits. The only caveat is that all employees must be offered these benefits.
- More management and reporting: As a C-corp, you must set up shareholder and board of director meetings, as well as publish annual reports. This costs time and money for businesses, especially as C-corps continues to grow.
- Regulations and fees: There are more regulations on the federal and state level for corporations because of how C-corps are taxed. Many states also impose regular fees for corporations.
How to structure a corporation
Filing to become an S-corp or C-corp is relatively the same process, as S-corps often begin as C-corps or LLCs. The main difference is that S-corp owners must submit IRS Form 2553.
- Choose your corporation’s legal name and reserve it with the secretary of state (only applicable to some states)
- Draft articles of incorporation with the secretary of state
- Issue stock to shareholders
- Secure business licenses and certificates
- Apply and obtain an Employer Identification Number (EIN) by submitting IRS Form SS-4
- Apply for other state and local business ID numbers; these differ by state, but they relate to required corporate accounts such as payroll taxes, disability and unemployment
- To file for S-corp status, owners must submit Form 2553 to the IRS within 75 days of the corporation forming; this must be signed by all the company’s shareholders
Costs for setting up your business as a C-corp or S-corp remain similar. Depending on the state filing fees, you can expect to pay anywhere from $50 (Kentucky) for an S-corp to $725 (Nevada) for C-corp or S-corp status. You may want to hire a lawyer to navigate the complexities of incorporating your business, which can carry fees.
What's the difference between a C-corp and an S-corp?
The main difference between these two business entities are how they are taxed and who can own them. C-corps pay taxes as a corporation, and on the individual level whenever dividends or capital gains are paid out. S-corps choose to have their profits and losses pass directly to shareholders and bypass the corporate tax.
C-corps do not have any restrictions when it comes to the number of shareholders or if a shareholder is an individual, partnership or company. S-corps are limited to 100 shareholders, only offer common stock and legally can only have individuals as shareholders.
Are most corporations a C-corp or S-corp?
When you hear the word "corporation," it’s common to think of the big ones: Amazon, Walmart, Bank of America and Apple. These are all C corporations. C-corps account for about 6% of U.S. businesses and generate over half of the country’s business income. The IRS reported in 2014 that there were an estimated 4.6 million S corporations operating within the U.S.
Why would you choose an S corporation?
S-corps may be ideal for small businesses who are looking to not pay corporate taxes, and enjoy the protection that comes with being a corporation. This can be particularly good for small businesses that don’t have many owners or shareholders.
S-corps may be limited in how far and fast the business can scale, but because they elect to have profits and losses pass through the business directly to the shareholders, S-corps can provide considerable tax savings.
What do the C and S stand for?
The C and S refer to specific subchapters of the Internal Revenue Code. They help distinguish each other when it comes to how the businesses are taxed and what guidelines each type of corporate entity must follow.
What are the 4 types of corporations?
- C corporation
- S corporation
- LLC: Combines corporate business structure with some of the benefits of a partnership
- Nonprofit corporation: Nonprofits can operate as corporations but cannot pay out any dividends; instead, profits go back into the organization
How are C-corp and S-corps taxed?
S-corps are are not taxed at the corporate level. The revenue from the company is distributed directly to shareholders, who then pay taxes based on their individual tax bracket. C-corps pay a corporate tax (currently 21%) on any profits. When the company pays out dividends or capital gains, shareholders are responsible for paying taxes on the individual level for this money.