S-Corp vs. C-Corp: How to Choose the Right Business Structure
When you start a business, one of the first decisions you’ll need to make is selecting your business structure. If you want to go the corporation route, you might find yourself perplexed over which type of corporation is right for you: S corporation or C corporation?
We’ll explain what makes each type of corporate entity unique and how to decide between an S-corp vs. C-corp for your business.
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S corp and C corp definitions
There are two main types of corporations: S-corps and C-corps. Each has advantages and disadvantages, so let’s review what makes a corporate entity different and how to decide between an S-corp vs. C-corp for your business.
What is a corporation?
A corporation is a legal entity that is separate and distinct from its owners. Corporations can enter into contracts, earn profits, pay taxes and be held legally liable.
Business owners and investors sometimes prefer to incorporate a business because it offers protection from legal liability for its shareholders. For example, if the corporation enters into a contract with another party and then breaches that contract, any resulting lawsuit is against the corporation — not its shareholders or officers. This protects the shareholders’ personal assets.
On the other hand, corporations are more expensive to form and maintain than other types of business entities and require more paperwork, recordkeeping and formalities.
What is an S-corp?
An S corporation is a type of corporation that offers many of the advantages of a corporation, including limited liability protection for its owners but is treated as a pass-through business for tax purposes.
This means the S-corp doesn’t pay taxes directly on its profits. Instead, the company’s profits and losses pass through to the shareholders, who then report and pay taxes on their individual income tax returns.
However, to qualify for S-corp status, the company must meet the following requirements:
- The company must be a domestic corporation, meaning it was created or organized in the U.S., not a foreign country
- Have only individuals, certain trusts and estates as shareholders (partnerships, other corporations and non-resident aliens can’t be shareholders of an S-corp)
- Have no more than 100 shareholders
- Have only one class of stock
- Not be a financial institution, insurance company or domestic international sales corporation
What is a C-corp?
A C corporation offers all of the advantages of a corporation, including limited liability protection for its owners and more flexibility in the types of owners it can have.
However, with a C-Corp, the company’s profits are taxed twice: once at the corporate level and then again when distributed as dividends to shareholders.
S-corp vs. C-corp compared
It’s important to understand the differences between S-corps vs. C-corps to choose the right structure for your business. We outlined the key features of each type of corporation so that you can decide which one best suits your needs.
|Taxation: gains||Shareholders pay taxes on gains on their individual tax returns.||Corporations pay income taxes at a flat rate of 21%.|
|Taxation: losses||Shareholder ability to deduct losses may be limited.||C-corps can carry any unused net operating losses forward indefinitely, offsetting taxable income in future years.|
|Tax filing schedule||Form 1120-S due March 15||Form 1120 due April 15|
|Equity financing||Difficult to raise capital||Easier to raise capital|
|Stock issuing classes||One class of stock||Can have multiple classes of stock|
Pros and cons
When it comes to taking a look at the pros and cons with both S-corps and C-corps, a lot of it comes down to how you prefer to pay taxes on business income and flexibility around shareholders and issuing stock.
S-corp pros and cons
No double taxation: Income passes through to shareholder returns, so there’s no double taxation of profits.
Limited liability. S-corp shareholders receive limited liability protection.
Potentially higher tax rates: The highest tax bracket for individuals is 37% — significantly higher than the 21% tax rate that applies to C-corps.
Shareholder limitations. S-corps can have no more than 100 shareholders, and those shareholders can’t be partnerships or other corporations.
C-corp pros and cons
Easier to raise equity financing: It’s easier for C-corps to raise money via equity financing because they can issue multiple classes of stock and have fewer shareholder restrictions.
Transferability. Corporate shareholders can freely sell or transfer their shares.
Double taxation: Corporate profits are taxed twice: once at the corporate level and again as dividends paid to shareholders.
More cost and formalities. It can be costly to incorporate a business, comply with corporate formalities, file corporate tax returns, and keep up with administrative requirements.
Alternative business entities to consider
While an S-corp or C-corp are some common options for structuring a business, there are alternative types of business structures you might consider.
Other business entities
Sole proprietorship: A sole proprietorship is an unincorporated business owned and operated by one individual.
- Advantages: Allows for easy setup and operation, as well as providing the owner with complete control over all decisions related to the business.
- Disadvantages: Sole proprietors have unlimited liability for all debts and obligations of the business.
LLC: A Limited Liability Company (LLC) is like a hybrid of a sole proprietorship and a corporation.
- Advantage: LLCs provide owners with limited liability for the business’s debts and obligations.
- Disadvantage: they are taxed as pass-through entities, so profits and losses are only reported on the owners’ individual tax returns.
Partnership: A partnership is an unincorporated business owned by two or more individuals.
- Advantages: Allows for easy setup and operation and provides the owners with shared control over all decisions related to the business. Profits from a partnership are taxed at the individual level, not at the corporate level.
- Disadvantage: Partners have unlimited personal liability for all debts and obligations of the business.
- Nonprofit corporation: A nonprofit corporation is a corporation that is organized for charitable, educational, religious, literary or scientific purposes and is exempt from federal income tax. Nonprofit corporations must meet certain criteria to qualify for tax-exempt status and are subject to different rules and regulations than traditional business entities.
- B-corp: A B-corp, or Benefit Corporation, is a type of for-profit legal entity recognized by some states. While the tax treatment of B-corps is the same as C-corp, they’re required to provide some kind of public benefit in addition to seeking financial profit. States that allow B-corps may require them to submit annual reports documenting their contributions.
Frequently asked questions
It’s possible for an S-corp to become a C-Corp, as long as it meets the eligibility requirements, including not having more than 100 shareholders or more than one class of stock. To revoke your S-corp election, file a written statement with the same IRS service center where you made your initial election. This process will result in different tax and legal implications for the business, so it’s a good idea to consult an accountant or attorney before making any changes.
The process of forming a corporation varies from state to state but generally involves filing articles of incorporation with the secretary of state’s office and paying a fee.
The cost also varies depending on the state in which you’re incorporating but generally ranges from $50 to $315. Some states also require an annual fee or franchise tax to maintain the corporation’s status. It’s a good idea to consult a lawyer or accountant before forming a corporation to ensure you comply with state law.
Double taxation is a term used to describe the taxation of the same income twice, such as when a corporation pays taxes on profits, then shareholders pay taxes on those profits again when they receive dividends from the corporation.
Double taxation can burden businesses and individuals, as it reduces the amount of money available to them after paying taxes.