S Corp vs C Corp: Key Differences

Business owners reviewing their business entity type c corp vs s corp

When you’re starting a business, one of the most crucial decisions you’ll face is selecting the right business entity. The choice between an S Corporation (S Corp) and a C Corporation (C Corp) has heavy implications in terms of your business’s taxation, ownership structure, and compliance requirements. Taking the time to fully understand the key differences between these two entities can empower you to make an informed decision that aligns with your business goals now and in the future.

S Corporations Explained

An S Corporation, commonly referred to as an S Corp, is a certain type of corporation that comes into existence through an IRS tax election. One of the biggest benefits of an S Corp is the avoidance of double taxation. What that means is, instead of the corporation itself being taxed, the income passes through to the shareholders and is taxed at the individual level. [1]

However, not every business can become an S Corp. There are specific criteria that must be met, such as having no more than 100 shareholders, all of whom must be U.S. citizens or permanent residents. Not only that, but, an S Corp can only issue one class of stock and must be a domestic corporation.

C Corporations Explained

Not to be confused with an S Corp, a C Corporation, or C Corp, is the standard corporation entity under IRS rules. C Corps face double taxation—first, the corporation pays taxes on its income, and then shareholders pay taxes on dividends. This might sound less attractive, but C Corps offer other advantages that can outweigh this drawback.

C Corps can have an unlimited number of shareholders, including foreign investors, and they can issue multiple classes of stock. This flexibility is highly beneficial for businesses looking to raise substantial capital or go public. The broader ownership and investment potential make C Corps suitable for larger, more complex businesses.

Key Differences

The most notable differences between S Corps and C Corps revolve around taxation, ownership, and regulatory requirements.

Taxation

business owner reviewing his taxes online to decide if his business should be filed as an s corp or c corp

The taxation model is the primary distinction. S Corps benefit from pass-through taxation [2], meaning the income is only taxed at the shareholder level. On the other hand, C Corps are subject to double taxation—once at the corporate level and again at the individual level when dividends are distributed.

Ownership

S Corps are limited to 100 shareholders, who must all be U.S. citizens or residents. This makes them suitable for smaller, domestic businesses. In contrast, C Corps can have an unlimited number of shareholders, including foreign investors, making them ideal for businesses seeking significant growth and investment.

Stock Classes

S Corps can only issue one class of stock, which can limit their financial structuring options. Meanwhile, C Corps can issue multiple classes of stock, providing greater flexibility in financial and investment strategies.

Formalities and Compliance

Both types of corporations must adhere to formalities such as holding annual meetings, adopting bylaws, and maintaining minutes. However, C Corps often face more stringent reporting and compliance requirements.

Advantages of Filing as an S Corp

Opting for an S Corp can offer several benefits. The most notable advantage is the avoidance of double taxation, with income only taxed at the shareholder level.

Also, S Corp shareholders can be employees, paying themselves a reasonable salary and taking the remaining income as dividends, which are not subject to self-employment tax. This can result in further tax advantages.

The simpler ownership structure of an S Corp, with fewer shareholders and restrictions, can also be easier to manage.

Drawbacks of S Corporations

Despite the benefits, there are also downsides to choosing an S Corp. The strict eligibility requirements, such as the 100-shareholder limit and the necessity for shareholders to be U.S. citizens or residents, can be restrictive.

The limitation to one class of stock can hinder financial structuring options and reduce investor appeal. Furthermore, S Corps must adhere to many of the same formalities as C Corps, which can be administratively burdensome.

Lastly, S Corps must continually meet the IRS’s stringent qualifications to maintain their status, adding to the administrative load.

Advantages of Filing as a C Corp

Filing as a C Corp also comes with its own set of advantages. One of the most significant is the potential for unlimited growth. C Corps can have an unlimited number of shareholders [3] and can issue multiple classes of stock, making it easier to attract investors and raise capital.

The ability to issue preferred stock and the lack of ownership restrictions make C Corps appealing to venture capitalists and institutional investors. C Corps can deduct the cost of employee benefits like health insurance, providing further savings.

Another advantage is the corporate tax rate, which can be beneficial, especially for businesses that retain earnings for growth rather than distributing dividends.

Drawbacks of C Corporations

But C Corps are not without their disadvantages. The most significant drawback is double taxation. Corporate earnings are taxed first at the corporate level and again when distributed as dividends to shareholders.

The complexity and cost of maintaining a C Corp can also be higher. C Corps involve more rigorous regulations and higher costs of compliance, including detailed record-keeping and reporting requirements.

As larger and more complex entities, C Corps may face greater scrutiny from regulatory bodies and increased public transparency, especially if they go public. The double taxation on dividends can also lead to a higher overall tax burden compared to S Corps.

Selecting the Right Entity for Your Business

Choosing between an S Corp and a C Corp ultimately depends on various factors, including your business goals, size and future plans.

Business Size and Growth Plans

If you plan to keep your business small and closely held, an S Corp might be the better option due to its tax benefits and simpler structure. However, if you aim for significant growth and seek outside investment, a C Corp’s ability to attract capital might be more suitable.

business owner fufilling shipments, his business is growing

Tax Considerations

Evaluate the tax implications of both structures. S Corps can be advantageous for avoiding double taxation, while C Corps might benefit from lower corporate tax rates and deductible benefits.

Ownership Structure

Consider the ownership restrictions and stock flexibility. S Corps have strict limitations, whereas C Corps offer more flexibility with unlimited shareholders and multiple classes of stock.

Regulatory and Compliance Requirements

Assess your ability to handle the regulatory and compliance demands of each structure. C Corps generally require more rigorous reporting and governance.

Long-term Goals

Think about your long-term business goals. If going public or expanding internationally is in your plans, a C Corp may offer more opportunities.

Consulting with legal and financial advisors can provide further clarity tailored to your specific situation. Understanding the key differences and weighing the pros and cons will help you make an informed decision, setting a solid foundation for your business’s future success.

Sources

1. Staff, C. C. (2021, May 30). C corporations advantages & disadvantages. https://www.wolterskluwer.com/en/expert-insights/c-corporations-advantages-and-disadvantages#:~:text=This%20means%20a%20C%20corporation,%2Dmentioned%20%E2%80%9Cdouble%20taxation%E2%80%9D.

“This means a C corporation pays corporate income tax on its income, after offsetting income with losses, deductions, and credits. A corporation pays its shareholders dividends from its after-tax income. The shareholders then pay personal income taxes on the dividends. This is the often-mentioned “double taxation”.”

 2. Berry-Johnson, J. (2023, December 6). What are the benefits of pass-through taxation? LegalZoom. https://www.legalzoom.com/articles/what-are-the-benefits-of-pass-through-taxation#

“Pass-through businesses don’t have to deal with double taxation. Instead, the company’s revenues and expenses “pass-through” to the business owner’s tax return, where the owner pays tax on profits or deducts losses along with their other personal income and expenses.”

 3. West Virginia Secretary of State. (n.d.). C corporations. https://www.law.wvu.edu/files/d/5db2be06-4ea4-48fe-b5f5-7eaced1efe59/eilc-c-corporations-final.pdf

“There is no limit to the number of shareholders a C corp may allow”

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