S Corp vs. C Corp: The Key Differences To Consider (2024)

Are you planning to form a corporation? Understanding the differences between S corps and C corps is essential. Explore the tax implications, and the benefits of each.

While S corps and C corps may sound similar, there are key differences in how these two entity types are formed, as well as their tax benefits, stock structures, and operational requirements.

What is an S corp?

An S corporation (S corp) is a legal entity with a special tax designation defined by its pass-through tax status. By electing to be taxed under Subchapter S of the United States Internal Revenue Code, S corps can avoid paying corporate income taxes. Instead, they pass all business income, losses, deductions, and credits through to shareholders for federal tax purposes. 

Shareholders then report the distributions on their personal tax returns, with taxes assessed at their personal income tax rates. The main benefit of an S corporation is that it avoids double taxation on corporate income.

What is a C corp?

A C corp is a company that issues stocks to shareholders and is run by a board of directors. Many large US companies, such as Microsoft and Walmart, are C corporations—their income is taxed under Subchapter C of the United States Internal Revenue Code. 

The key defining features of C corps lie in liability and tax treatment. Like S corps, C corps shield their shareholders from business-related liability. This means that if someone sues a C corp, they cannot reach the personal assets of its shareholders.

However, C corps are subject to what’s known as “double taxation.” The corporation itself is taxed on its income, and shareholders are taxed again on any dividends they receive from the company.

What are the differences between S corps and C corps?

The main difference between S corps and C corps lies in their federal income tax liability and ownership structures. Understanding these differences is important for small business owners making early stage decisions about their business structure, as these choices can affect long-term payouts to shareholders.

Here’s an overview of the key similarities and differences between the two types of corporations.

Requirements for forming an S corp

There are strict requirements for creating an S corporation: 

• Must be a domestic business (formed or incorporated within the US)
• Cannot be an ineligible corporation (e.g., certain financial institutions, insurance companies)
• Can have only one class of stock
• Maximum of 100 shareholders
• Shareholders must be individuals, certain trusts, or estates
• Shareholders must be US citizens or legal residents
• Partnerships and corporations cannot be shareholders
• Must file Form 2553 with the IRS

Requirements for forming a C corp

C corporations offer more flexibility. To form a C corp, you must:

• File articles of incorporation with the state
• Have a unique business name
• Appoint directors
• Issue stock
• Adopt bylaws
• Hold initial board of directors meeting
• Obtain necessary business licenses and permits
• Apply for an employer identification number (EIN) with the IRS

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Formation

The formation of S corps and C corps are similar. Both require filing articles of incorporation, adopting bylaws, obtaining an employer identification number (EIN), and maintaining compliance with state requirements. 

The main difference in the formation process is electing S corp status, which involves filing IRS Form 2553 within a specified time frame. States may also have different requirements for S and C corporations, depending on their laws and regulations.

For more detailed information on starting each type of corporation:

• How To Start an S corp: Set Up an S corp in 10 Steps
• What Is a C corporation? Pros & Cons, Tax Treatment

Fundraising

Both S corps and C corps can be funded through the issuance of stock. However, there are some key differences:

• C corps can issue both common and preferred stock. Common stock comes with voting privileges; preferred stock doesn’t, but offers priority in receiving dividends or payouts if the company is liquidated. 
• S corps are limited to offering one class of stock.

Shareholders

While both S corps and C corps allow shareholders to own portions of the business, there are significant differences in shareholder regulations:

• S corps can have a maximum of 100 shareholders, all of whom must be individuals (not corporations) and US citizens or permanent residents. If an S corp transfers ownership to a non-resident after formation, it will lose its tax status.
• C corps have no restrictions on the number or type of shareholders. They can issue shares to individuals, corporations, nonprofits, and even foreign citizens.

Taxes

Shareholders for both S corps and C corps pay personal-rate taxes on corporate distributions. (These are usually referred to as “dividends” when issued by C corps.) Both structures shield shareholders from corporate liability, protecting their personal assets in the event of litigation.

However, there are key differences in how these entities are taxed:

• C corps pay corporate income tax, and their shareholders pay taxes on any distributions from the company, resulting in double taxation. 
• S corps enjoy pass-through tax treatment, meaning shareholders pay personal income taxes on distributions from the company only. 
• S corps also benefit from a 20% pass-through deduction on qualified business income (QBI) under the Tax Cuts and Jobs Act of 2017.

Operations

Both S corps and C corps have similar operational requirements:

• Appointing corporate officers, including a board of directors
• Holding annual board meetings and keeping detailed minutes of each session 
• Drafting, filing, and abiding by company bylaws regarding: 
• Board composition and voting procedures
• Stock issuance
• Scheduling of annual meetings
• Filing an annual report
• Maintaining a registered agent 

Formation costs

While costs can vary, forming a corporation can be more expensive than other business structures:

• According to ContractsCounsel’s marketplace data, the average cost of forming an S corp is $1,200. 
• The same source found the average cost of starting a C corp to be around $633.

It’s important to note that S and C corps can be more expensive to form compared with other structures, such as LLCs or sole proprietorships. However, the benefits of these corporate structures may outweigh the initial costs for many businesses.

How to maintain compliance as an S corp or C corp

Running an incorporated business comes with its share of paperwork and legal requirements. Whether you choose an S corp or C corp, you’ll need to stay compliant to keep your business in good standing.

S corp

S corps are generally considered more challenging to comply with due to their strict eligibility requirements and tax allocation rules. Here are key areas to focus on:

Salary-dividend balancing: S corp owners pay themselves a salary and take distributions. Finding the right balance is important because:

• Paying yourself too little salary might attract IRS attention.
• Paying too much means missing out on potential tax savings.

The key is to give yourself “reasonable compensation” for your role. Consider what you would pay someone else to do your job, and the norm in your industry. 

Passive income: If more than 25% of your gross receipts come from passive activities (such as rent, interest, or certain royalties), you could face an extra tax. To avoid this, do the following:

• Keep close track of your income sources.
• Consider restructuring passive income-generating assets.
• Plan your income streams strategically throughout the year.

State-level compliance: While focusing on federal rules, don’t overlook state-specific requirements:

• Some states don’t recognize S corp status and will tax you as a C corp.
• Others have additional filing or tax requirements.
• A few states even have their own version of the S corp election.

Stay informed about your state’s rules, especially if you do business in multiple states.

Timely filings: Beyond the annual Form 1120S, don’t forget about the following:

• Estimated tax payments for the corporation (in some cases)
• State tax filings and reports
• Any required information returns (like 1099s for contractors)

Missing deadlines can result in penalties or even jeopardize your S corp status.

Accidental termination: Losing your S corp status can happen more easily than you might think. Reasons include:

• Transferring shares to an ineligible shareholder
• Exceeding the 100-shareholder limit
• Creating a subsidiary without making a qualified subchapter S subsidiary election

C corp

C corps have more requirements but are generally more straightforward and less restrictive than S corps. They offer more flexibility in ownership structure and don’t risk losing their status due to compliance issues. 

At a high level, C corps must:

• File annual reports and pay all associated fees
• Maintain corporate records
• Hold board meetings
• Complete tax filings
• Follow corporate governance
• Document all stock issuances and transfers
• Manage employee compliance
• Meet state-specific requirements 

How to change your corporation’s tax status

Changing your corporation’s tax status isn’t as complicated as it might seem. It mainly involves filing the right paperwork with the IRS. Here’s the basic process:

1. Check eligibility: Ensure your business meets the requirements for the desired tax status.
2. Get shareholder approval: If you have other shareholders, you’ll need their agreement to change the tax status. Make sure everyone understands the implications of the change.
3. File IRS Form 2553: This is the main step for changing from a C corp to an S corp. Submit form 2553 to the IRS between November 8 and January 22.
4. Wait for IRS approval: The IRS will review your form and notify you of their decision. This process can take a few weeks.
5. Update your bookkeeping: Once approved, adjust your tax handling and financial records to match your new status.

Going from an S corp back to a C corp is usually simpler. In most cases, you just need to file your taxes as a C corp, and the IRS will automatically treat you as one.

When is it better to create an LLC instead of a C corp or an S corp? 

With all this talk about corporations, you might be wondering if a limited liability company (LLC) is a better fit for your business. Here are some situations where an LLC could be the superior choice:

1. Simpler setup and management: LLCs are easier to set up and run than corporations. With less paperwork and fewer formal requirements, you can spend less time on administrative tasks and more time focusing on your business.
2. Flexibility in taxation: LLCs can choose how they want to be taxed. You can opt for taxation as a sole proprietorship, partnership, or even as an S corporation.
3. Fewer restrictions on ownership: Unlike S corps, which have limits on the number and type of shareholders, LLCs don’t have these restrictions. This makes LLCs a good choice over S corps if you want to have foreign investors or other businesses as owners.
4. Credibility boost: Forming an LLC can make your business seem more established and professional compared to operating as a sole proprietorship, which can be helpful when dealing with customers or other businesses.

💡 Note: The best choice depends on your specific situation. It’s always a good idea to talk to a lawyer or accountant before making a final decision.

S corp vs. C corp: Which is best for you?

Choosing between types of corporations requires you to consider several important questions:

• Do you need or want to raise money for your company by issuing stock?
• Do you foresee having investors who are foreign or business entities?
• Do you ever intend to sell your company?
• How large of a shareholder pool do you envision in the immediate future? In five years?
• Can you afford double taxation? If not, can you bear the extra IRS scrutiny?

Answering these questions will likely guide you to the best option for your business. Remember, you’re not limited to just S corps and C corps. An LLC, partnership, or even a sole proprietorship might be a better fit for your needs when starting your business.

S corp vs. C corp FAQ

Can an S corp have foreign shareholders?

No, an S corporation cannot have foreign shareholders. The IRS requires all S corp shareholders to be US citizens or residents.

What’s the difference between an S corp and a C corp?

An S corp is a corporation that has elected to be taxed under Subchapter S of the Internal Revenue Code. This means that profits and losses pass through to shareholders and are reported on their personal income tax returns, avoiding the double taxation that applies to C corps. C corps are taxed separately from owners, subject to double taxation, have fewer restrictions on shareholders, and face more complex filing requirements.

Who pays more taxes, an S corp or a C corp?

Generally, a business with S corporation status pays less in taxes than a C corporation due to pass-through taxation. S corporations’ income passes through to shareholders, who are taxed at their individual income tax rates. C corporations are taxed at the corporate level, which tends to be higher than individual tax rates.

How do I know if a company is a C corp or an S corp?

You can determine if a company is a C corp or an S corp by checking their public records, such as their filing with the Internal Revenue Service (IRS) or their articles of incorporation. You can also contact the company directly and ask for this information.

What is better: an LLC or an S corp?

The best choice depends on your business’s specific needs and goals. An LLC offers more flexibility in terms of corporate structure, taxation, and management. S corporations provide certain tax advantages, such as avoiding double taxation and potential special tax treatment for shareholders. Consider consulting with a financial adviser or lawyer to determine the best option for your startup.