S Corporation vs. C Corporation

Generally speaking, a C Corp is what gets established when a company goes to incorporate. An S Corp, on the other hand, is when a corporation elects are taxed differently. There are advantages to this type of tax structure that a C Corp does not otherwise get under IRS regulations. The letters S and C come from the tax code under which the respective corporations are taxed. In this article, we look at the key differences between S Corps and C Corps as well as the advantages/disadvantages associated with each of these business structures.

Key Similarities Between S and C Corps

• Liability protection. Any type of corporate structure does offer protection against the business’s liabilities. That is to say, if the business has accrued significant debt, or if they are facing legal action, the owners’ assets are not at risk given the corporate structure. Regardless if we are dealing with an S or a C Corp, this holds for both entities.
• Formation documents. When forming either an S or C Corp, documents must be filed with the state in which the corporation is located. These documents are known as the Articles of Incorporation.
• Corporate structure. Both C and S Corps have very similar structures. They each have shareholders who are the owners of the company. The shareholders in turn are responsible for choosing the board of directors. This board will oversee the corporation as far as key decisions; however, they will not direct the day-to-day operations in most cases.

Key Differences Between S and C Corps

Taxation

Perhaps the biggest difference between these business structures is how they are taxed. Again, an S Corp is a corporation that elects to get taxed differently from a C Corp under IRS rules.

• C corps are entities that are taxed separately under the IRS code. That means that with a C Corp, they will have to file a corporate tax return. This will then require them to pay corporate taxes. Additionally, when income from the company is distributed to shareholders in the form of dividends this also gets taxed on the owners’ returns. This is what is known as double taxation. So the income tax is paid initially on the corporate level and then again in terms of personal income tax.
• S corps are considered pass-through tax entities. What this means is that the only income tax that gets paid is at the personal level — there is no corporate income tax that gets paid. Rather, the business’s profits are passed through to the owner’s tax returns and any tax that is owed gets paid in that way.

Ownership

In terms of who can own each of these corporate entities, the IRS does have some restrictions in place, particularly regarding corporate ownership of an S Corp.

• S corps can have a maximum of 100 shareholders. Additionally, all of those shareholders have to be citizens of the US. With C Corps there are no such restrictions in place.
• S corporations are only able to have one class of stock and C Corps can have multiple classes.

Advantages and Disadvantages of Both

As with anything, there are going to be pros and cons to each of these corporate structures. So in determining which to form, it is important to think through the details and understand beforehand the advantages as well as the disadvantages that you might experience with each entity.

S Corps:

Single taxation

The primary advantage of an S Corp is that you avoid the double taxation of a C Corp. You do not have to pay taxes at the corporate level, just the taxes on business profits that you receive in the form of income on your returns.

Pass-through of losses

Because an S Corp’s losses get passed through to the shareholders (as well as the profits) these losses can then be used to a certain extent to offset income.

Limited shareholders

An S Corp cannot have more than 100 shareholders, meaning it can’t go public and this, in turn, limits its ability to raise capital from new investors.

Other shareholder restrictions

Shareholders of an S Corp have to be US citizens. This could put an S Corp at a disadvantage as far as raising money from investors, depending on where the investors come from.

Sell/Transferring restrictions

When it comes to selling and/or transferring shares, S Corps do have to put limitations on this. This is because they could potentially end up with shareholders who are ineligible if such transfers/sales were to take place.

C Corps:

No cap on shareholders

A C Corp can have as many shareholders as it needs and/or wants. Unlike with an S Corp, there is no limit to the number of owners a company can have.

No owner restrictions

Unlike with an S Corp, a C Corp can also have owners who are not from the United States and are thus not US citizens.

More investment options

Again, because there are no restrictions or caps on ownerships, a C Corp has more options when it comes to raising funds for the business. Venture capitalists and other types of investors are therefore more apt to look into investing in C Corps first.

Double taxation

The primary downside of a C Corp is the fact that they are taxed twice. The first comes with the corporate tax the company must pay, and then of course the owners pay tax on the dividends that are paid to them.