S Corp vs. C Corp: Understanding the Difference
Many of the most well-known businesses — like Apple, Alphabet (aka Google) and Microsoft — are corporations. A corporation is one of many ways you can structure a business, like a sole proprietorship, limited liability company or partnership. Corporations are created when a business is incorporated by a group of owners called shareholders. The corporation is a legal entity separate and distinct from its owners, so its shareholders are not personally liable for the company’s debts.
When you’re starting a business, or changing your business structure and are looking to incorporate, you can choose from a variety of corporation structures, but two common options are the C corporation and S corporation.
A C corporation, or C-corp can have an unlimited number of shareholders. C-corps pay corporate income tax on their profits, and their shareholders pay personal income tax on dividends they receive (aka double taxation).
An S corporation, or S-corp, is limited to 100 shareholders. An S-corp is a pass-through entity — it does not pay corporate income tax and instead passes along profits or losses to shareholders, who pay personal income taxes on those profits. As a result, an S-corp avoids double taxation.
Of course, there’s much more to know about each kind of corporation. We go into more detail below:
Corporations are recognized as a legal person under the law, so they enjoy most of the rights and liability that a person would. They can enter into contracts, hire employees, sue others and get sued just like people can.
State laws, the U.S. Securities and Exchange Commission and the IRS require corporations to maintain a higher standard of record-keeping, operational processes and reporting compared with companies not structured as corporations (though requirements will vary by state). A corporation can’t simply register with their secretary of state’s office. It is required to do things like elect a board of directors to oversee the business operations, elect board officers, issue stock to shareholders, file an annual report, hold annual shareholder meetings and create and follow bylaws. A corporation may also cost more money to form and maintain than other structures, which we address later on.
“There are a whole bunch of rules and regulations that you have to comply with and follow up with each and every year,” said Joel Youngs, regional chair of the professional development committee for the national Small Business Development Centers. He says structuring as a corporation may not be worth it for a business if it’s not profitable enough to cover the additional overhead expenses.
An S corporation, or S-corp, is a corporation that acts as pass-through entity for federal tax purposes. Instead of being taxed at the current 21% corporate tax rate, the company’s income or loss passes through to its shareholders proportionally, and the income or loss is then taxed at the individual income tax rate on the individual’s federal tax returns. As a result, S-corps avoid having to pay income tax at both the corporate and personal levels, aka double taxation.
“S corporation gives the business owner a favorable tax treatment at the end of the year,” said Youngs. “It’s an effort by the IRS to help people save money on their taxes.”
Shareholders would file articles of incorporation with their particular secretary of state office. There will likely be a fee associated with the filing. In New York, for example, it costs $125 to file a Certificate of Incorporation. The company must file a Form 2553 signed by all shareholders to be identified and taxed as an S-corp.
No corporate tax
The S-corp is designed to avoid double taxation. That happens when a company’s profit is first taxed at the corporate tax rate, then, if shareholders are paid out dividends, the dividends are taxed at a rate based on the individual’s income.
S-corps avoid double taxation and instead act as pass-through entities. Because the company’s profit or loss is passed to the shareholders’ personal income tax, it is only taxed once.
Independent from owners
An S-corp is independent from its owners. If one shareholder leaves the company or sells their share of the company, the other shareholders can carry on the company.
S-corp owners have limited liability. Its owners are not liable for the company’s debts in the event the company cannot repay them.
No preferred stock
S-corps can only issue one class of stock: common stock. The company cannot issue preferred stock, a class of stock that entitles the shareholder to a fixed dividend and must be paid before common stock dividends. Because the company can only issue one kind of stock, owners may have less control over the company’s stock value.
No more than 100 shareholders
An S-corp cannot have more than 100 shareholders. All S-corp shareholders must be U.S. citizens and cannot be partnerships or other corporations.
The relatively small number of shareholders may become problematic if a business owner intends to raise a large amount of capital as he cannot issue shares as a C-corp would, says Bernard M. Kiely, a Morristown, N.J.-based certified public accountant (CPA) who works with business owners and also owns both an S-corp and a sole proprietorship.
However, an S-corp owner doesn’t typically want a large number of uninterested or uninvested shareholders, Kiely tells LendingTree.
“An S corporation is really for small businesses that really don’t make a distinction between the business or themselves personally,” added Kiely. They usually want the business’s few shareholders to be very interested or involved in the business’s operations, he said.
States may tax S-corps differently than the federal government, meaning you may not completely avoid double taxation. But, according to the Small Business Administration, most states recognize S-corps the same way that the federal government does. Others may only tax S-corps above a certain threshold while others may treat the company as a C-corp.
A C corporation is your standard corporation, and the company is completely independent from its shareholders. To form a C-corp, shareholders would simply need to file articles of incorporation with their state’s secretary of state office.
C-corp owners have limited liability, so they are not liable for the company’s debts if the company cannot repay them.
Attract investors and employees
C corporations can sell stock or shares and don’t have a legal cap on the number of shareholders like S-corps do. A C-corp can raise funds by selling stock, which may provide the company financial flexibility. C corporations can also offer employees stock option plans. Additionally, if the company plans to go public, it will need to be structured as a C-corp.
The C-corp is independent of its owners. So if an owner decides to leave or sell his share of the company, it can generally continue operating without a hitch.
C-corporations are subject to double taxation. The company pays corporate income tax on its profits and shareholders must pay tax on dividends paid to them on their personal tax returns.
C-corps can issue an unlimited number of shares to an unlimited number of shareholders. Oftentimes C-corporations may have millions of shares and shareholders. Many of those shareholders have little interest in the day-to-day happenings of the company and may not work for the company. This is a downside if you’re more interested in highly invested shareholders than raising capital, says Kiely.
Highlighting the differences
The S corporation and C corporation have many similarities, but they have a few crucial differences.
|Ownership||Can have no more than 100 shareholders. All of the shareholders must be U.S. citizens and can only hold one class of stock. The owners cannot be other partnerships or corporations.||Can have an unlimited number of shareholders who do not have to be U.S. citizens or residents. There are no restrictions on the kinds of people or entities that can purchase stock.|
|Shareholder rights||All shareholders hold the same class of stock, so a shareholder’s voting power is directly tied to the amount of stock he holds. Shareholders also have the right to receive disbursements, or a share of the company’s profit. The income is reported on an IRS Schedule K-1.||Shareholders may have different rights, depending on the class of stock they own. If a shareholder owns preferred stock, he generally does not have voting rights but is entitled to receive dividends before common shareholders. In the event the company’s assets are liquidated, preferred shareholders and others are paid before common shareholders. Common shareholders generally have voting rights and rights to the remaining assets in the event of liquidation after all other debts are settled.|
|Taxation||The S-corp is a pass-through entity designed to avoid double taxation The company’s net profit or loss is shown on a Form 1120S, but the amount is passed through proportionally to its shareholders, who must then report the income on a Schedule K-1 with their personal tax return.||Subject to double taxation. The company pays taxes once on the business’s profit at the corporate rate. Then tax is again assessed when the shareholder receives a dividend and reports the amount as income on his tax returns.|
If you’re deciding between setting up your company as a C-corp or an S-corp, you should consider things like the risk involved in your business operations, how involved you want the company’s shareholders to be in the business and what your goals are in choosing the corporate structure in the first place, Kiely tells LendingTree.
Try to answer the following questions before you decide to incorporate.
Are you trying to save money on taxes?
Some business owners mistakenly think structuring their company as a corporation will save them money during tax time, Kiely tells LendingTree. With a corporation, you can’t write off any more expenses than you would as a sole proprietor or another pass-through entity. He says there are small savings with a corporation, as you are allowed to deduct the business’s half of employment taxes as a business expense. But, the additional overhead cost required to maintain a corporation may not be worth it (more on that in the FAQ section below).
“When you sit down with your accountant and your attorney and your business advisers there’s got to be some overarching reason to drive you to a C corporation,” said Youngs. The overhead costs may outweigh any tax benefit, especially for those structured as S-corporations as they are taxed like any other pass-through entity, and you could receive the same protections structured as a limited liability company instead.
How involved do you want your shareholders to be?
With S-corps, the shareholders are usually very involved in the business as employees, Kiely tells LendingTree. For example, a small technology company with some highly involved engineers may be structured as an S-corp and give a few engineers some stock and make them shareholders, so they feel that much more invested in the company.
“A C corporation has no interested shareholders,” said Kiely. “You can be a shareholder of Ford without having a driver’s license, a car or anything.” The distance allows the company to raise a load of capital without having to get its shareholders involved in its day-to-day processes, but it can be problematic for smaller companies who want a tighter knit group of shareholders.
What does the future of the company look like?
The C-corp structure is more ideal for companies that want to last a long, long time. For example, if you are a barber, and open up a barber shop with only a few employees, you probably don’t expect the company to outlive you. In that case, says Kiely, you may want to form an S corporation to keep shareholders close and decrease the number of people you’d need to contact if you don’t pass it onto an heir and the company shuts its doors.
On the other hand, a company like Ford Motor Co. was intended to grow internationally and last several decades or centuries, says Kiely. It needed to be a C corporation to raise enough capital from shareholders and investors to grow on such a large scale.
If you want the protection of a corporation, but your business has little to no need for financing and you want shareholders to have an interest in the company, you would elect the S-corp. However, if you’re aiming to grow into a large company and need to raise funding, you’d be better off electing the C-corp.
To form a corporation, one or more people, called “incorporators” need to submit articles of incorporation with the appropriate state department. There will likely be a fee associated with the filing. The incorporators must be at least 18 years old, as all states require the principals of a company that incorporates to be 18 years or older.
Filing fees vary by state. We gave a New York example earlier, so here’s a different one: In Nevada, the fee is based on the value of the total number of authorized shares stated in the Articles of Incorporation, starting at $75 and maxing out at $35,000 for the highest-valued companies.
The filing is all that’s required to incorporate, but after you’ve created it, the corporation will need to fulfill several responsibilities.
Incorporators must create and adopt corporation bylaws. They then must elect a board of directors, who oversee the company and elect company officers. At that point, the company must be sure to keep correct and complete records, per state and federal regulations.
To structure a company as an S-corp, owners go through the same process to create a C-corp and then elect to be taxed as an S-corp. To do this, all shareholders must sign and submit a Form 2553 to the IRS.
According to the IRS, S-corps must meet the following qualifications:
- Be a domestic corporation
- Have only allowable shareholders
- May be individuals, certain trusts and estates
- May not be partnerships, corporations or non-resident alien shareholders
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation (i.e. certain financial institutions, insurance companies and domestic international sales corporations)
Can I start a business without creating a corporation or an LLC?
Yes. You can start a sole proprietorship as a single owner, or a partnership with at least one other person. However, the sole proprietorship and partnership structures lack the limited liability protection provided by corporations and LLCs. There is no formal action you need to take to be taxed as a sole proprietorship or partnership, as the IRS considers them disregarded entities (entities not separate from its owner for tax purposes). Just be sure to follow any state and local licensing requirements, and file the correct forms at tax time.
Do I need licenses or permits to start my business?
Possibly. Almost every business — even home-based businesses — requires some sort of license or permit. There may be federal, state and local licensing and permit requirements you need to comply with to run your business.
Any required licensing or permits will depend on your industry and the location of your business. Here’s a checklist to review when licensing your small business.
How much will it cost to run and form a corporation?
It varies. State filing fees can vary widely. As we saw in our previous example with New York’s $125 filing fee and Nevada’s $35,000 maximum. Pricing will depend on the state in which you choose to incorporate. The corporation will also need to meet certain requirements that are likely to cost some amount; for example, hiring a lawyer to help draft bylaws, or recruiting a staff member to organize and maintain notes for every shareholder meeting. The corporation may need to hire an accountant to help file more complex tax forms, or create and submit its annual reports to the secretary of state, Kiely tells LendingTree. The total cost to create and maintain a corporation will depend on the cost of these elements in addition to any periodic registration, licensing and permit renewals.
Do I need an attorney to form a corporation?
You don’t need to hire an attorney, but it’s a very good idea, as forming a corporation with shareholders can be a complex process. You can complete an articles of incorporation file without the help of a lawyer, but it’s advisable to consult with a corporate attorney to identify and assist you in navigating the tax and legal requirements a corporation must abide by.