Table of Contents
What is an S corp?
An S corporation (S corp) is a legal entity and tax designation defined by its pass-through tax status. By electing to be taxed under Subchapter S of the Internal Revenue Code, S corps may forgo paying corporate income taxes and instead pass all business income, losses, deductions, and credits through to shareholders for federal tax purposes.
Those shareholders then report the distributions on their personal tax returns, and taxes are assessed at their personal income tax rates. This allows an S corp to avoid 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. Big US companies like Microsoft and Walmart are C corporations—that is, 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, however. Like S corps, C corps shield their shareholders from business-related liability. Anyone who sues a C corp cannot reach the personal assets of its shareholders.
C corps are taxed on corporate income, and shareholders are taxed again on any dividends they receive from the company. This is called “double taxation.”
What is the difference between an S corp vs C corp?
The main difference between an S Corp and C Corp lies in federal income tax liability and ownership. S corps are pass-through entities, where profits and losses pass through to shareholders’ personal tax returns. C corps are separate taxable entities, subject to double taxation.
S corps have ownership restrictions, while C corps offer more flexibility but potentially higher tax implications. Both entities offer limited liability protections.
It’s important for any small business owner to understand these differences in order to make early stage decisions on your business structure that might affect long-term payouts to shareholders.
Here’s an overview of the key similarities and differences between the two types of corporations.
|Attribute||S Corporation||C Corporation|
|Formation||Articles of Incorporation and IRS Form 2553.||Articles of Incorporation.|
|Fundraising||One class of stock.||Common or preferred stock.|
|Shareholders||US citizens or permanent residents. Up to 100 shareholders.||No restrictions on number or type of shareholder.|
|Operations||Must elect officers, hold annual board meetings, follow bylaws.||Must elect officers, hold annual board meetings, follow bylaws.|
|Taxes||Shareholders pay personal tax on distributions.||Required to pay business tax on income.|
|Formation costs||$1,200, on average.||$633, on average.|
The formation of S corps and C corps are similar. For both, you need to file Articles of Incorporation, adopt bylaws, obtain an employer identification number (EIN), and maintain compliance with state requirements.
There’s one major difference in the formation process: electing S corp status, which involves filing IRS Form 2553. S corps have to complete this step within a certain time frame. States may also have different requirements for S and C corporations, depending on their laws and regulations.
Here’s more information on how to start each type of corporation:
- How To Start an S Corp: Set Up an S Corp in 10 Steps
- What Is a C Corporation? How To Form and Operate a C Corp
Both can be funded through the issuance of stock.
C corps can issue common or preferred stock. Common stock comes with voting privileges; preferred stock comes with no voting privileges, but preferred stockholders jump the line in terms of priority when it comes to receiving dividends, or payouts if a company is liquidated. S corps are limited to offering one class of stock.
Both S corps and C corps allow shareholders, which means multiple people can own portions of the business.
S corps need to observe rules about the number of shareholders and who their shareholders can be that C corps do not. S corps may issue shares to a maximum of 100 shareholders, all of whom must be actual people (not corporations) who are US citizens or permanent residents. If an S Corp transfers ownership to a nonresident after formation, it will lose its tax status.
C corps may issue as many shares as they like to anyone or anything they like: corporations, nonprofits, citizens of foreign countries even.
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 shield shareholders from corporate liability, protecting their personal assets in the event of litigation.
C corps pay corporate income tax, and their shareholders pay taxes on any distributions from the company, meaning dividends are essentially taxed twice. S corps enjoy pass-through tax treatment, meaning shareholders pay personal income taxes on distributions from the company only.
Both S corps and C corps require appointing corporate officers; e.g., a board of directors. These boards must meet at least annually and keep detailed minutes of each session.
Both entity types must draft, file, and abide by company bylaws regarding the makeup and voting of boards, issuance of stock, scheduling of annual meetings, etc. They both also must file an annual report and have a registered agent.
S corp vs. C corp: Which is best for you?
Choosing between types of corporations requires entrepreneurs to ask a number of 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?
Navigating these questions will likely lead you to the best option for your business. But if not, don’t worry—you are not trapped in a dichotomy of S corps and C corps. Perhaps an LLC, partnership, or even a sole proprietorship is a better fit for your needs when starting your business.