When starting a new business, one of the first issues you will have to deal with concerns the choice of business structure. For many small businesses, the two options are S-corporations (S-Corp) and C-Corporations (C-Corp). Understanding the difference between S Corp and C Corp, and the advantages and disadvantages of each, can be confusing. Here’s a look at what you need to know before choosing between an S-Corp and C-Corp for your business.

If you happen to be trying to build a technology startup or large company, here are some reasons why incorporating in Delaware as a C-Corporation would be a good choice.

Remember, if you have any questions or concerns about choosing between an S-Corp or C-Corp, or regarding any other business issues, it’s always a good idea to consult with an expert, like an experienced business attorney.

What is a C-Corporation?

C-corporations are those with a standard corporation form. They are legally owned by shareholders and limit the amount of each individual shareholder’s liability for business debt to the amount each has invested in the company. A C-Corp is formed with the filing of its incorporation documents (typically its Articles of Organization) and payment of fees in the state chosen for incorporation.

What is an S-Corporation?

An S-corporation allows a company to pay no direct taxes on its income, instead allowing income to “pass-through" (be passed on to shareholders) and be declared on the shareholders’ personal tax returns. An S-Corp is originally formed as a C-Corp, after which the company elects to become an S-Corp.

C- or S-Corporation Choice is Critical for Small Businesses

Tax benefits are usually the determining factor in choosing the S-Corp form, particularly for small businesses. The tax and personal asset protections afforded by S-Corp status aid small businesses in securing financing during crucial early stages of growth. Choosing between C-Corp and S-Corp status can mean the difference between success or failure for a small business and, therefore, should only be made following consultation with an attorney.

S-Corp vs. C-Corp: Pros and Cons

It is important to understand the pros and cons of both business structures before deciding on which best suits your company’s needs.

Business Structure

Pros

Cons

S Corporation

  • Taxed as a pass-through entity.

  • Avoids double taxation.

  • No corporate level taxation.

  • Losses can be used to offset other income.

  • Assets protected in the event of litigation.

  • Limitations on business type (such as financial and insurance).

  • Restricted to 100 shareholders.

  • All shareholders must be U.S. citizens or residents (with the possible exception of family members).

  • Only one class of stock allowed.

  • For technology startups seeking venture capital, venture capitalists dislike the S Corporation structure due to limitations on the number of shareholders and the restriction for only one class of stock.

C Corporation

  • Allowed for any type of business.

  • More growth available since there is no restriction on the number of shareholders.

  • Allows investments by non-U.S. citizens.

  • Multiple classes of stock allowed which also allow dividing up voting rights.

  • Assets protected in the event of litigation.

  • Income is double-taxed (i.e., paid by both corporation and shareholders).

  • Shareholders share in the income and pay taxes but do not share in losses.

Similarities between S-Corporations and C-Corporations:

There are 4 main similarities between S-Corporations and C-Corporations:

  1. Liability protection for owners. For both types, there is no liability beyond the amount invested for debts of business.

  2. Strict corporate structure. Corporations have shareholders, directors, and officers. Shareholders own the company and elect the board of directors. Directors oversee larger corporate issues such as corporate goals and decision making and elect officers. Officers are in charge of day-to-day decisions within the business.

  3. Corporate documents and compliance with the state. Both corporations file certain incorporation documents, typically Articles of Incorporation or Certificates of Incorporation, and have obligations to issue stock, creating and maintaining bylaws, organizing and taking meeting minutes of shareholder and director meetings, filing annual reports, and paying annual fees.

  4. Separate Entities. Both types of corporations create separate legal entities in the state with “unlimited life” which continue to exist after the death of the owners.

Frequently Asked Questions

  • What does the “S” in S-corporation stand for?

The “S” stands for “small business” and refers to the limitation on the number of shareholders (100) who may participate in the business under the S-Corp election.

  • Do C-Corps have K-1's?

C-Corporations do not issue K-1s, which are used for partnerships. Instead, a Form 1099-DIV is issued when the corporation pays dividends, and individual shareholders receiving the dividends are taxed on the dividend income.

  • Once the S-Corp election is made, can it be changed?

Yes. A corporation is not tied to its C-Corp/S-Corp selection. Meeting certain requirements, a corporation is free to switch from one form to the other.

Steps to Forming an S-Corporation

There are three steps to successfully forming an S-Corporation:

  1. Forming the Corporation – You cannot elect S-Corporation status until after you have formed your corporation. You must meet the IRS guidelines, which include being a U. S. Corporation, having only qualified shareholders, having fewer than 100 shareholders, and authorizing only one class of stock. Banks, insurance companies and international sales companies are typically not eligible for S-Corporation status, however.

  2. File IRS Forms Form 2553 must be filled out, signed by all shareholders, and filed with the Internal Revenue Service. In most cases, a properly completed and filed S-Corp election made after March 15 will become effective in the following tax year.

  3. Claiming Taxes – All income from the S-Corporation is to be included on personal income tax returns and taxed at individual tax rates.

As a side note, an S-Corporation may choose to drop its S status and go back to C status any time, but it must wait at least 5 years to refile for its S status again.

Helpful Information:

IRS Form 2553 - Election by a Small Business Corporation

IRS Form 1120 - U.S. Corporation Income Tax Return

IRS Form 1120S - U.S. S Corporate Income Tax Return

IRS Form 1099-DIV - Dividends and Distributions

IRS Schedule E - Supplemental Income and Loss

Next Steps

If you need help forming an S Corporation or C Corporation and all the steps that come afterwards, you can post your question or concern 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, Stripe and Twilio.