Has your business been growing recently? Are you no longer eligible as a sole proprietor or single-member LLC? Have you been looking to form a corporation?
If so, you’ve come to the C Corporation vs S Corporation crossroads. You need to figure out whether you’re going to be an S corp or a C corp.
In order to do that, you need to understand the differences between a C Corp versus an S Corp. From financial obligations to the inner organization of each corporation, there is so much to learn.
Just keep reading to learn everything you need to know.
What Is a Corporation?
A corporation is a a company or group of people authorized to act as a single entity (legally a person) and recognized as such in law.
When someone forms their business into a corporation, they’ll start having access to all of the benefits that come with the title. The most beloved advantage is limited liability. This term refers to the fact that your corporation will take any liabilities that come up.
This means that you won’t have to take care of liabilities personally.
However, in order to take advantage of this pro and others, you need to make sure that you’re organizing your corporation in the most advantageous way possible. This means that you need to decide whether you’re going to form into a C Corporation or an S Corporation.
What Is a C Corporation?
A C Corporation is a standard form of corporation. All C Corporations are owned by shareholders. This division of ownership limits the amount of liability that each individual shareholder takes when something goes wrong.
The shareholding model also limits each person’s debt to the company to the amount that they invested in the company.
A business that wants to form a C-Corp needs to file its incorporation documents in the state that it’s incorporating within. In addition to these documents, the company needs to pay the fees that that state has for incorporating.
What Is an S Corporation?
An S Corporation allows a business to avoid income tax on its taxable income. Rather, the taxes pass through onto the shareholders. Thus, the shareholders report the business’ earnings on their personal tax returns.
The S Corporation is the most popular tax structure of corporations in the United States. In fact, they’re the second-most popular tax structure of any business type. It lies behind sole proprietorships.
An S-Corp election can be made after a business has already formed a C-Corp or a Limited Liability Company. Once a business establishes itself as a C-Corp or LLC, it can then elect whether or not it wants to become an S-Corp.
C-Corporation Versus S-Corporation for Small Businesses
The determining factor between a C-Corp and an S-Corp sometimes comes down to taxes. Since small businesses are at a tax disadvantage, it’s important for each one to choose the right corporation status for them.
In most cases, the S Corporation is the way to go for small businesses. It gives small business owners the flexibility that they need to protect their personal assets while controlling taxation. With these benefits, your small business will be in a better place financially.
However, before you commit to either kind of corporation, you should consult an attorney. An experienced attorney can help you determine which corporation suits your business specifically.
C-Corp Versus S-Corp: The Similarities
There are four main similarities that you should take into consideration when choosing between a C-Corp and an S-Corp:
- Liability protection for business owners
- Unwavering corporate structure
- Documentation and compliance
- Individual entities
Let’s look at each characteristic in-depth.
1. Liability Protection for Business Owners
Both the C-Corp and S-Corp give the business owner a waiver from complete liability. Rather than having to take on all of the company’s liabilities, the business owner splits liability with the shareholders.
Each shareholder is only reliable for the amount of money that they have invested in the business. Therefore, they aren’t responsible for anyone else’s share in the business, and they don’t have to pay for liabilities all by themselves.
2. Unwavering Corporate Structure
All corporations have a strict structure. There are directors, officers, and shareholders that each lies in a specific dynamic in relation to one another.
The shareholders are the business owners. They are the ones that are funding the business and allowing it to run its everyday operations.
The shareholders of the company elect the directions that make up the board of directors. These individuals oversee and handle large corporate issues like decision-making and goal implementation.
The board of directors elects officers. Officers are the ones who take care of day-to-day operations within the business. They handle the regular everyday decisions.
3. Documentation and Compliance
Both C Corporations and S Corporations have to handle documentation. Unfortunately, it’s just a part of the legalities that each state requires.
The main required documents that corporations have to form are known as the Articles of Incorporation or Certificates of Incorporation.
Within these and other documents, each corporation has to issue company stocks, create bylaws, maintain regulations, organize meetings, file annual reports, pay fees, and more. The specific inner-workings of a corporation will depend on the needs of the corporation itself.
4. Individual Entities
Lastly, it’s important to recognize that both types of corporations are individual entities. By forming a business into a corporation, you’re making that corporation into a legal being that has an unlimited life.
This means that the corporation can stand on its own in legal matters. This also means that the corporation will live on even if every shareholder were to pass away.
C-Corp and S-Corp Comparison: The Differences
Now that we’ve gone over the few similarities that you can find between these two corporations, it’s important to note the differences. By recognizing these individual characteristics, you can make the best decision for your company.
Let’s look at the pros and cons for C Corporations and S Corporations.
C Corporation Pros and Cons
A C Corporation may be the right choice for your business if you’re trying to take advantage of these pros:
- Any kind of business can become a C-Corp
- Your business can grow to any size since C Corporations don’t have a shareholder limit
- Non-U.S. citizens can invest in your company
- Business entities can own shares of your company
- Multiple kinds of stocks are allowed for C-Corp businesses so you can divide voting rights
- Your business’ assets will be protected in the case of litigation
Even with all of these pros, there are two cons to consider.
First, the income of a C Corp business gets taxed twice. The corporation and its shareholders pay taxes on the earnings.
Second, shareholders share when it comes to income and taxation. However, they don’t share in the losses that the business incurs.
S Corporation Pros and Cons
An S Corporation may be the right type of corporation for your business if you like these advantages:
- Your business is taxed as a pass-through entity, meaning that only shareholders pay taxes
- There is no double taxation as seen with C-Corps
- There is no taxation at the corporate level
- The losses of an S-Corp can be used to offset other income that shareholders may be making
- Your assets are protected in the case of litigation
- Your business may get a 20% qualified business income deduction
That last one is a huge advantage for small business owners. Those small business tax deductions can make a big difference come tax season.
Although S Corporations are popular for small businesses, there are many cons/disadvantages to think about. However, most of these downsides are only going to affect bigger businesses.
Here are the cons of owning an S-Corp:
- There are limitations on the kinds of businesses that can become S-Corps
- Every S-Corp is limited to 100 shareholders
- All of the shareholders for S-Corps must be U.S. citizens or U.S. residents
- There is only one class of stock allowed
Because of these limitations, S Corporations have more trouble with venture capitalists. Most of these individuals don’t like the limitations that S-Corps have on their shareholder amount and stock type.
Overall, the S-Corp can be a great choice for small businesses that are still within stockholder limitations. However, you may want to change to a C-Corp once your business begins to reach the threshold.
C-Corp Versus S-Corp: Frequently Asked Questions
When it comes to C Corporations and S Corporations, we find that people have more questions beyond the similarities and differences.
If you have a question about corporations, see if the answer is here.
1. What does the “S” in S Corporation stand for?
The “S” stands for Subchapter S of the Internal Revenue Code. Since all S Corporations have limitations for shareholders, it’s important to recognize that S Corporations are a popular choice for small business owners.
Keep in mind that the shareholder limitation for S Corporations is 100. If your business has more than 100 owners or may soon be over that threshold, you should consider documenting your business as a C Corporation instead.
2. Do C Corporations Issue Schedule K-1s?
A Schedule K-1 is a type of documentation that partnerships and S-Corporations issue. C Corporations do not use Schedule K-1s.
C-Corps must issue Form 1099-DIV to report dividends paid to shareholders. This form goes to each C-Corp shareholder after the corporation pays dividends. From there, individual shareholders report dividends that they need to account for on their tax returns.
Remember, both the corporation (income) and the shareholders (dividends) are taxed in C-Corporations.
3. Can I Change My Mind After Choosing an S-Corp or C-Corp?
Your business is not tied to its corporation election. In other words, you can change your mind after submitting documentation. However, you must review the tax and legal consequences of making a change to your corporate status.
C Corporation Versus S Corporation: The Final Decision
If you’re still left wondering after all of this information, we’re going to make it simple.
Consider these questions:
- Am I a U.S. resident?
- Does my business have 100 or fewer shareholders?
- Is my business going to stay at its current size for the short-term future?
- Do I want to pass taxation through to the shareholders?
- Am I going to liquidate my assets or sell my business within the next ten years?
If you answered “yes” to most of those questions, it’s likely that the S-Corp is the right fit for you.
Now, consider these questions:
- Am I a non-U.S. resident?
- Does my business currently have more than 100 shareholders?
- Is my business going to have more than 100 shareholders in the near future?
- Do I want to take advantage of funds from angel investors?
- Do I want to take advantage of low corporate tax rates as a high-rate taxpayer?
- Am I going to sell my shares of my business in the future?
If you answered “yes” to most of these questions, it’s likely that the C-Corp is the right choice for your business. For those who answered “yes” to the last question, you should review the tax implications of selling your business before making this decision.
If you’re still left wondering after this assessment, we highly recommend that you speak with an attorney. They can look over the specific needs for your business and help you choose the right corporation status for your business right now.
Get the Tax Help That You Need
No matter what decision you make, your business is going to need some help navigating taxes. As we discussed, the taxation for C Corporations and S Corporations are different. Unless you’re a tax expert yourself, it’s likely that some of these tax laws and regulations have your head spinning.
Luckily, you’ve come to the right place. Our team at Propel CFO knows how to distinguish C Corporation versus S Corporation finances. With this information, we can help you make the most of your financial situation.
This includes major financial guidance during tax season, no matter which corporation you choose.
Go ahead and get started today with a free, 30-minute consultation with our certified public accountant.