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Difference between C Corp and S Corp

When you’re planning your business, you have a lot of momentum behind you. You need to figure out the perfect business idea and one-of-a-kind business name. But think about it, is that all you need? No, not yet! Many aspiring small business owners come to a halt when they understand that before they start with making the profit, they need to choose a business entity carefully and deliberately.

But as a small business owner, who may not have much knowledge about which business entity to choose, you can easily get trapped in this confusion. So, let’s discuss the two main corporations, C Corp and S Corp and decide which one is right for you.

Before we look at the difference between C Corp and S Corp status, we will first look at what they have in common.

Owners of a corporation are known as shareholders, and directors who are elected by the shareholders to oversee the business operations. The directors hire officers to handle the day-to-day operations. Profits, called dividends, are distributed among shareholders of the company, according to the number of shares they own. A corporation is established by preparing articles of incorporation and filing registration documents with the state.

It is mandatory for corporations to issue stock, hold annual director and shareholder meetings, adopt bylaws, issue written corporate resolutions for important decisions, and file annual reports with the state and pay annual fees. Failure to do these may lead to loss of the personal liability protection and dissolution of the corporation.

Setting up a corporation gives limited personal liability to its owners. A corporation is set up under state law and is legally a separate entity from its owners. As a separate legal entity, the only assets of the corporation are subject to corporate debts. However, there are some exceptions, a shareholder is not personally liable for corporate debts, and assets of the shareholder are guarded against business creditors.

Now, let’s move onto the difference between the two:

Formation

Both C and S corporations need to file articles of incorporation with the state. Not every corporation can become an S Corp.; To become an S Corporation, all the shareholders are required to sign and file Form 2553 with the IRS. It is mandatory to meet the five requirements:

  • The company needs to be a domestic corporation,
  • The company has no more than 100 shareholders.
  • The only shareholders are individuals, estates, certain organizations, or corporations, such as financial institutions and insurance companies, are specifically excluded from S Corp status.
  • The company has no nonresident alien shareholders.
  • The company has only one class of stock.

But C Corporations do not have such eligibility criteria.

Ownership

Ownership in an S corporation is limited to individuals who are U.S. citizens or resident aliens. Other businesses are not allowed to own shares in an S corporation. C corporations, on the other hand, may have partnerships, limited liability companies, foreign businesses and other corporations participating as owners of the company. S corporations may be better suited for smaller-sized businesses, since they can have no more than 100 shareholders participating as owners of the company. C corporations can have as many shareholders as they want.

Structure

Both C and S corporations comprise of shareholders, directors, and officers. Shareholders are the owners of the company, and they elect the board of directors who are responsible for handling the corporate decision making and electing the officers who run the business on a day-to-day level.

C corporations are permitted to have any number of shareholders, out of which any of them can be a legal entity and multiple classes of stock. While the S corporation law limits them to 100 shareholders or less, and none of them are corporations, partnerships, or any kind of trusts and only have one class of stock.

Most Professionals recommend a “C Corporation,” as it provides a little more flexibility when starting a business if you plan to grow, or expand the ownership or sell your corporation.

Fringe Benefits

C corporations can deduct the cost of fringe benefits provided to employees, such as disability and health insurance. Shareholders who work for a C corporation do not pay taxes on fringe benefits received from the company. This holds true as long as the C corporation provides the fringe benefit to 70 percent of its employees. Shareholders employed by an S corporation who own more than 2 percent of the company cannot deduct fringe benefits.

Taxes

A big difference between a C corporation and an S corporation is the way that each entity gets taxed. S corporations are treated as pass-through entities, where taxation “passes through” to the company’s owners, who report their share of profits and losses directly on their personal income tax return. S corporations are therefore not required to file taxes on the business level. C corporations, on the other hand, have a double layer of taxation. They have to file taxes with the Internal Revenue Service, and the owners are required to report dividends received from the company on their personal tax return. In Short,

C corporations

C corps are separately taxable entities. They file a corporate tax return (Form 1120) and pay taxes at the corporate level. They also face the possibility of double taxation if corporate income is distributed to business owners as dividends, which are considered personal income. Tax on corporate income is paid first at the corporate level and again at the individual level on dividends.

S corporations

S corps are pass-through tax entities. They file an informational federal return (Form 1120S), but no income tax is paid at the corporate level. The profits/losses of the business are instead “passed-through” the business and reported on the owners’ personal tax returns. Any tax due is paid at the individual level by the owners.

Personal Income Taxes

With both types of corporations, personal income tax is due both on any salary drawn from the corporation and from any dividends received from the corporation.

Stock Considerations

A C corporation can issue multiple classes of stock, while S corporations cannot issue more than one class of stock. The various stock classes issued by a C corporation may carry various voting and profit privileges for the shareholders of the company. Since a C corporation’s stock may be owned by a foreign person or business, a C corporation can operate the company in a global capacity.

Conclusion

C-Corps and S-Corps are more similar than different. C-Corps have more flexibility for shareholder rights and ownership, but face tax implications for this privilege. In general, larger companies opt for forming as a C-Corp, while small to medium sized businesses often choose incorporating as an S-Corp. So, before selecting the type of corporation for your business, it is always advisable to consult a business consultant or a professional attorney.