Difference Between S and C Corp: Everything You Need to Know
The difference between S and C Corps is that S-Corp owners are taxed once by the federal government, whereas C-Corp owners are subjected to double taxation.3 min read
The difference between S and C Corps is that S-Corp owners are taxed once by the federal government, whereas C-Corp owners are subjected to double taxation. In terms of ownership, businesses treated as S corporations can only have a maximum of 100 owners who are individual US citizens or residents. C-Corps can have different types of shareholders, including US or non-US citizens and entities.
The Business Owner's Dilemma: S Corporation or C Corporation?
The S Corporation is not an entity type, but a tax classification that the IRS can bestow on certain LLCs and corporations. Therefore, C-Corps and S-Corps have similar initial formation procedures. They must file the relevant documents with the state. New Corporations are, by default classified as C Corporations. LLCs and corporations that desire to be classified as S corporations communicate their desire to the IRS using Form 2553.
Whether to register a business as an S corporation or a C corporation is a question many potential and current business owners ask. It is important to make the right decision because the decision will likely have wide-ranging implications for the business. Generally, large corporations are better off as C-Corps but smaller and medium-sized business can get some benefits by being taxed as S-Corps. If you want to start a bank or insurance company, the decision has already been made for you: IRS guidelines do not allow such businesses to be treated as S corporations. The differences between S corporations and C corporations are discussed below.
Number and Type of Owners
The law prevents most big corporations from requesting S-Corp treatment. This is because the ownership of S-Corps is limited to a maximum of 100 individuals who are US citizens or US residents. S-Corps are also not allowed to have most trusts, partnerships, or corporations as owners. C-Corps can have any number and type of shareholders including non-US persons and entities.
Rights of Shareholders
The flexibility of ownership of C-Corps is extended even to shareholders. While S-Corps can have only one class of stock, C-Corps can have a variety of shareholder categories with different voting powers. This flexibility can make it easier for founding members to allow new shareholders to be drafted in to bring the money needed to grow the business.
Most people are aware of the double taxation situation in C-Corps which is not available in S-Corps. It is true that C-Corps must pay corporate taxes in addition to income tax on the dividends of individual shareholders. S-Corps, on the other hand, are not subject to corporate tax and this might enable their owners to keep more money after income tax. Enabling owners to avoid double taxation is not the only tax advantage of S-Corps.
Owners of new corporations that will be operating at loss for the first years can get another tax benefit from choosing to have the corporation taxed an S-Corp. The owners can use their share of the losses arising from the S Corporation to offset personal incomes obtained elsewhere on their personal income tax returns. This can reduce the owners' individual tax burdens. This provision is not available to C-Corp owners.
Selling the Business
A business sold as an S corporation will likely attract fewer taxes compared to a similar business sold as a C corporation.
Health, Life, and Disability Insurance
One of the tax benefits available to C-Corp shareholder-employees is that the C corporation can deduct the cost of benefits like health, life and, disability insurance from their taxes. This provision is available to corporations that extend out such benefits to 70 percent or more of its employees. S-Corp owner-employees can not deduct the value of such benefits from taxes.
While it is true that big corporations and most small businesses with high-growth goals will only thrive if they are treated as C-corps for tax purposes, not all small and medium-sized businesses need to request for S-Corp treatment. The decision about entity election should be made after a thorough analysis of the tax, ownership, and legal implications. Professional tax lawyers in your state can help you come to the right decision.
If you need help deciding between an S-Corp and a C-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.