C Corporation or S Corporation: Everything You Need to Know
Whether a C corporation or an S corporation is right for your company will depend on the size and future plans of the business.3 min read
Whether a C corporation or an S corporation is right for your company will depend on the size and future plans of the business. Knowing the major differences as well as the benefits and downsides to each is essential to making the right choice.
Basics of C Corporations and S Corporations
Any business owner forming a corporation will automatically start with a C corporation (C corp) status, which is the most common business structure in the country.
S corporations (S corps) are created when a business entity elects S corp status with the IRS (Internal Revenue Service) by filing Form 2553. An S corp status can be elected by most types of business entities and is usually done for tax purposes. Subchapter S of the IRC (Internal Revenue Code) spells out the provisions for this type of tax status, which is why these businesses are called S corporations.
If a business wants to claim S corp status for the fiscal year, it must file Form 2553 by the 15th day of the month that falls three months after the end of its fiscal year. For instance, if a corporation's fiscal year ends in February, it'll need to elect S corp status by May 15th to be treated as an S corp the following year.
Certain states actually require businesses to elect S corp status with the state, in addition to the IRS, once the business is incorporated.
Taxation of C Corporations and S Corporations
C corporations and S corporations are taxed very differently, and this is arguably their most important difference, as many business owners choose S corp status in particular to save money on taxes.
C corps are required to pay federal corporate taxes on their company income by filing Form 1120, a corporate tax return. Any profits distributed to the C corporation shareholders as dividends will also be taxed through the personal income tax returns of the shareholders.
This leads to what is called "double taxation" because the company's income is taxed twice:
- Once at the corporate level
- Again at the individual shareholder level.
The executives in a C corporation are also taxed on the salaries they are paid through the corporation.
Electing S corp status can help avoid double taxation. This is because the corporation will no longer be viewed as its own separate entity but as a disregarded entity when it comes to taxation. The income of an S corp is passed through to the owners or shareholders of the company and reported on their income tax returns.
S corps are not taxed at a corporate level. Therefore, the income of the company is only taxed once. An S corp is still required to file Form 1120-S to report the company income. However, it won't owe taxes on it.
Shareholders in an S corp will receive Schedule K-1 forms that document how much money was passed through to them for the year. In this way, they:
- Know exactly what to report on their tax returns.
- Treat company losses as a write-off on the personal tax returns of S corp shareholders.
This is especially beneficial to small-business owners during their first year of startup when losses are more likely.
If you do choose to elect S corp status, be sure to file your taxes carefully. The IRS takes S corp filings very seriously, as some may try to commit tax fraud with this particular taxation setup. Your S corp status can be terminated if any errors are made.
Ownership of C Corporations and S Corporations
Another big difference between C corps and S corps is their requirements for ownership or shareholders. With both C corps and S corps, the owners of the corporation also serve as the shareholders.
C corps have no restrictions on their shareholders. Individuals can own stock without being U.S. citizens or residents, and other business entities, even foreign entities, can be shareholders in a C corp.
S corporations must meet these requirements when it comes to ownership:
- An S corp can only have up to 100 shareholders.
- S corps can only offer one type of stock.
- Shareholders in an S corp must be citizens and residents of the U.S.
- S corps cannot be owned by any other business entities, such as LLCs, corporations, or partnerships.
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