Difference Between C and S Corp: Everything You Need to Know
The difference between C and S Corp entities is that C-Corps are taxed twice by the IRS as compared to S-Corps, which are only taxed once. 3 min read
2. How Businesses Become S Corporations
3. Differences Between an S Corporation and a C Corporation
The difference between C and S Corp entities is that C-Corps are taxed twice by the IRS as compared to S-Corps, which are only taxed once. S-Corps are, however, are limited in that they can only have US Citizens or permanent resident owners. S-Corps can't have more than 100 owners, and they must have one class of stock or membership.
C Corporations Vs S Corporations
The S corporation is actually not an entity type, it is just a designation showing a distinct tax treatment system that is available to some corporations and LLCs. Entities that are treated as S corporations are formed the normal way by filing documents with the home state. Therefore, corporations that are treated as S corporation have a similar structure to a C corporation. All new corporations are automatically treated as C corporations by the IRS.
The two corporation types share the following similarities:
- For both types, personal income tax is levied on any salary received from the corporation.
- Both are obligated to issue stock.
- Both are required to create bylaws.
- Both corporations types must hold formal management and shareholders' meetings.
S corporation treatment may be beneficial to businesses in the situations discussed below:
- Small businesses use this classification to avoid double taxation.
- Owners of new corporations that anticipate operating at loss in their first few years also benefit from being classified as S corporations. The S-Corp classification enables the owners to write off losses in their personal income statements. This can offset income from other sources and reduce the tax burden.
- Owners who want to sell the business might get some benefits from selling it as an S-Corp because taxable gains from S corporations are normally less than those of C corporations
How Businesses Become S Corporations
An entity can decide to be taxed as an S corporation by conducting an election and then filing Form 2553 with the IRS. The business can revoke the election at any time. But should the same business desire to be treated as an S-Corp again, it must wait another five years after the revocation.
Differences Between an S Corporation and a C Corporation
C corporations are taxed as entities. They file corporate tax returns using Form 1120 and pay taxes at the corporate level. The dividends distributed to the shareholders are also taxed as the personal income of the shareholders. S Corporations, on the other hand, are treated as pass-through entities by the IRS. Though they file tax returns using Form 1120S, they are not taxed by the IRS. The business' profits or losses are passed through to the business owners. It is the owners that pay tax on their earnings to the IRS. Some businesses can, therefore, achieve significant tax savings by filing as S corporations.
Many states mirror the approach of the IRS when taxing S corporations. A few states, however, do not recognize the S corporation concept and tax S corporations the same way as C corporations. Business owners should consult experienced tax lawyers in their states to get reliable info about state taxes.
C corporations have a measure of freedom in the area of ownership arrangements. The number of shareholders is not limited. The law also allows other corporations, partnerships, or trusts to hold stock in a C corporation. S-Corps, on the other hand, are only allowed to have a maximum of 100 owners and these must be individual US citizens or residents. This makes C corporations the wise choice for business owners that intend to expand the business by selling shares.
Rights of Shareholders
S-Corps can only have one class of stock. However, there are no limits to stock categories in C-Corps. The C-Corp ownership structure can be made in a way that there are different groups of shareholders whose rights and votes have different weight. This can be used to reward founders with more voting rights than newer members, making it easy for shareholders to sell shares and expand without the fear of being eclipsed by new shareholders. This is impossible in an entity taxed as an S corporation.
Fringe Benefits to Owner-Employees
In the C corporation setting, if the corporation extends fringe benefits to at least 70 percent of the company's employees, the cost of those benefits is deductible from the taxes of employee-shareholders. The deductible is not available for most S-Corp employee-shareholders.
If you need help with deciding whether your business is better off as a C-Corp or an S-Corp, you can 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.