Corporation vs S Corporation: Everything You Need to Know
Corporation vs S corporation is a comparison that many entrepreneurs have to make when they are choosing a legal structure for their businesses. 3 min read
Corporation vs S corporation is a comparison that many entrepreneurs have to make when they are choosing a legal structure for their businesses. These two types of corporations have their pros and cons, which should be carefully weighed before making the final decision.
What Is a C Corporation?
A C corporation is the default business structure for a corporation. Unless your corporation has an “S” classification, it will be regarded as a C corporation. Normally, the owners of a C corporation are individual shareholders, which makes the corporation a separate legal entity. As such, a corporation offers personal liability protection for its owners. In other words, the shareholders of a corporation are not personally liable for its debts or liability.
While the shareholders make decisions regarding the company's important policy issues, the task of handling business issues is left in the hands of the board of directors. Officers such as CEOs, CTOs, and COOs are in charge of the company's day-to-day operations.
If you wish to elect C corporation status, you are required to submit certain documents to your state government. Typically, these documents include the articles of incorporation. After you have set up your corporation, you must fulfill certain documentation obligations and other requirements, such as issuing stock, holding shareholders' and directors' meetings, and paying fees.
Advantages and Disadvantages of a C Corporation
The advantages of a C corporation include:
- Limited liability – A C corporation has limited liability that protects its shareholders, directors, officers, and employees from its debts and obligations.
- Perpetual existence – A C corporation exists perpetually in that it will continue to exist even if the original owner has left the company or passed away.
- No shareholder limit – A C corporation is allowed to have as many shareholders as it wishes, as well as foreign shareholders.
- Easier to raise funds – Since it can issue multiple stock classes to any number of shareholders, a C corporation can raise funds more easily.
- Tax benefits – A C corporation can claim a tax deduction for the fringe benefits it provides its employees, such as health and disability insurance.
Likewise, the disadvantages of a C corporation include:
- Double taxation – A C corporation is required to pay taxes on its income at the corporate level and again at the individual level after the income is distributed to its shareholders as dividends. Additionally, the shareholders cannot deduct losses on their personal income statements.
- Regulatory compliance – A C corporation has to deal with a more complicated structuring process, which typically involves creating organizational resolutions, electing a board of directors, issuing stock, and others. C corporations must also meet strict compliance requirements after formation.
What Is an S Corporation?
Similar to a C corporation, an S corporation is owned by shareholders who are responsible for making high-level decisions. An S corporation also has a board of directors who determine the direction of the business and officers who handle its day-to-day operations. In addition, an S corporation also offers liability protection for its shareholders and has the same compliance and documentation obligations.
Advantages and Disadvantages of an S Corporation
S corporations offer many advantages, such as:
- Limited liability – Similar to a C corporation, an S corporation protects its shareholders, directors, executive officers, and employees from being personally liable for its debts and obligations.
- Pass-through taxation - An S corporation differs from a C corporation in that it is a pass-through tax entity and therefore not required to pay taxes on the company's income twice.
- Perpetual existence – An S corporation also exist perpetually, regardless of whether the original owner is still with the company.
- Tax-deductible losses – In an S corporation, owners can deduct their business losses on their personal tax returns.
- Investment opportunities – An S corporation can grow its business by attracting investors and issuing shares of stock.
The disadvantages of an S corporation are:
- Limited ownership – Unlike a C corporation, an S corporation can have a maximum of only 100 shareholders. Also, the shareholders must be legal U.S. residents.
- Greater tax scrutiny – In an S corporation, payments to shareholders and employees can be distributed as salaries or dividends. Since they are taxed differently, the IRS keeps a close eye on the company's tax filings.
- Regulatory compliance – An S corporation also has a more complex structuring and organizational process and required to meet strict compliance and documentation obligations throughout its existence.
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