Difference Between a C Corporation and S Corporation: Everything to Know
The difference between a C Corporation and S Corporation is important for those planning to incorporate their business.3 min read
2. Advantages of S Corporations vs. C Corporations
3. S Corp and C Corp Similarities
4. S Corp and C Corp Differences
The difference between a C Corporation and S Corporation is important for those planning to incorporate their business. The default formation is a C Corporation, while S Corporations have a special IRS tax status.
C Corporation vs. S Corporation
Limited liability companies and new corporations can elect a C Corporation or S Corporation status. S Corporations are “pass-through” entities, meaning all income is reported on the owners' personal tax returns, not on the business itself. To choose S Corporation status, make sure your business meets all requirements and file Form 2553 with the IRS.
C Corporations can file for S Corporation status following incorporation as long as they're eligible. S Corporations are called such because these entities are defined in the Internal Revenue Code's Subchapter S. C Corporations are not pass-through entities, so they are taxed at the corporate level. If dividends are distributed in a C Corporation, they are also taxed at the individual level.
Despite these differences, both entities are corporations and have a similar structure in regard to ownership, governance, liability, and capital generation. In both types of corporations, activities are legally separated from shareholder activities, including:
Advantages of S Corporations vs. C Corporations
There are many benefits to electing S Corp status over C Corp status. Smaller businesses tend to elect S Corporation status to avoid the double taxation inherent with C Corporations. Since new corporations will likely report losses during their initial years, they can benefit from S Corp status because owners can write off business losses on their personal income statements.
There are also benefits to selling an S Corporation over a C Corporation. For starters, S Corporations enjoy lower taxable gains than C Corporations, and they also continue to exist after an owner's death, similar to C Corp status.
S Corp and C Corp Similarities
Both S and C Corps offer limited liability protections to shareholders, meaning that the owners are not personally responsible for business liabilities and debts. Creating either corporation requires you to file documents with the state. These documents are generally called Articles of Incorporation.
Both S Corporations and S Corporations have directors, officers, and shareholders. Directors are responsible for electing officers to manage daily activities, while the shareholders are owners of the company who elect the board of directors.
All corporations regardless of status must follow the same corporate obligations and formalities, such as:
- Filing annual reports
- Adopting bylaws
- Holding director and shareholder meetings
- Issuing stock
- Paying annual fees
Both types of corporations enjoy the advantages of the “corporate shield,” which is a separation between the business and individual. Owners are not personally responsible for the debt incurred by the business, which offers certain protections if the company is sued. However, this corporate shield can be pierced if the owner participates in an activity outside legal bounds.
S Corp and C Corp Differences
C Corporations are considered separate taxable entities. They must file a Form 1120 and pay corporate-level taxes. C Corps may also face double taxation if any corporate income is distributed as dividends to the business owners. In other words, corporate income is taxed first and then again at the individual level.
By contrast, S Corporations are pass-through entities, meaning they aren't subject to taxes at the corporate level. Instead, all business profits and losses pass through to the individual owners and are reported on their personal tax returns. Taxes are then paid by these individuals, not the company itself.
Personal income taxes are due with either corporation status. This includes salary drawn from the business as well as dividends received.
Another difference is that S Corporations have ownership restrictions, C Corporations do not. S Corporations also cannot have more than 100 shareholders, all of which must be U.S. citizens or permanent residents. S Corporations cannot be owned by C Corporations, LLCs, other S Corporations, trusts, or partnerships.
C Corporations provide more flexibility when starting a business because it's easier to expand or sell a C Corp. S Corps only have one stock class, while C Corps have multiple. S Corporations have a single type of shareholder, which can be a drawback when it comes to selling shares or growing the business.
If you need additional helping understanding the difference between a C Corporation and S Corporation, post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.