S Corp vs C Corp: Key Differences and Advantages
S Corp vs C Corp is a controversial topic. Here's the difference between S Corp and C Corp, along with the pros and cons for the owner and investors.9 min read
The difference between a C corp and an S corp is important for those planning to incorporate their business. While the default formation is a C Corporation, S corporations have a special IRS tax status. Here’s what you need to know about their key differences.
Understanding Corporation Basics
So what are S corp and C corp? This guide will break down the differences between a C corp and an S corp, helping you to determine which business model is best for you. Check out also our article on how to determine if a company is a corporation.
What is an S Corporation?
S corporations are businesses that pass their income, losses, deductions, and credits through their shareholders for federal tax purposes. Shareholders of an S corporation must report their flow-through of income and loss on their personal tax returns and are assessed as their individual income tax rates. This way, S corporations are not subject to double taxation. S corporations will pay some built-in gains and passive income.
You must meet the following requirements to become an S corporation:
- Be a domestic corporation
- Have shareholders that are individuals, certain trusts, and estates, and cannot be partnerships, corporations or non-resident alien shareholders.
- Have less than 100 shareholders
- Have only one class of stock
- Not be an eligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations.
You must submit a Form 2553, Election by a Small Business Corporation signed by all the shareholders.
What is a C Corporation?
C corporations are the default structure of an incorporated business. C corporations are distinct from their legal owners and, thus, can enter into contracts or initiate legal action. If the C corporation is sued, then shareholders are only liable for their own investment and cannot be held personally liable.
You must meet the following requirements to become a C corporation:
- There needs to be an initial investment for business capital.
- Founding shareholders must receive stocks.
- There is a requirement to maintain records for corporate business. Personal records are not to be included.
You must submit Form 1120, U.S. Corporation Income Tax Form.
S Corp vs C Corp: Which is Right for You
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:
S Corp vs C Corp Formation Differences
Since C corporations are the default type of corporation, you are automatically designated as a C corp when you file articles of incorporation in your state. If you would like to be an S corporation, then you must file Form 2553. Depending on your state, you may need to file additional paperwork, as well.
S Corp vs C Corp Taxation Differences
S corporations are subject to pass-through taxation, where shareholders report business income and losses on a personal tax return. Shareholders only pass personal taxes, they do not pay corporate tax. C corporations pay double the tax. The business pays corporate tax, and then shareholders pay federal income tax through their dividends, a payment made to shareholders based on their investment in the company.
S Corp vs C Corp Ownership Differences
C corporations, other S corporations (with some exceptions), LLCs, partnerships, and trusts (with some exceptions) are not able to own S corporations. There are no ownership restrictions with C corporations.
Number of Shareholders
S corporations can only have up to 100 shareholders, and they must be American citizens. C corporations can have an unlimited amount of owners.
Classes of Stock
S corporations can only issue one class of stock. The stock must be a share representing an equal ownership stake. For example, a company cannot issue some stock that produces dividends and some that don’t. The only exception to this rule is that some shareholders may have different voting rights. This may occur when ownership is passed down to another family member.
C corporations typically issue common stocks and preferred stocks. Common stocks are the most common type of stock offered. It is used to share profits with the shareholder through dividends and capital appreciation. However, owners of common stocks are the last to get paid.
The number of common stocks owned also determined proportional voting rights. Those who own common stocks will also have the option to purchase more stocks if they become available. Preferred stocks are different from common stocks because they do not come with voting rights and are paid in dividends before the owners of the common stock. If the company were to go bankrupt, then preferred stock owners would get paid before common stock owners.
S corporations shareholders must be U.S. citizens or residents and must be natural persons. Thus, corporations and partnerships are not eligible to be shareholders. Certain trusts, estates, tax-exempt corporations, and 501(c)(3) are exempt from this rule.
C corporation shareholders are separate from the company and thus are not personally liable. There are no restrictions on being a shareholder.
Advantages and Disadvantages of S Corp
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.
Pros of S Corp
- Shareholder opinions. Having a limited number of shareholders allows you to listen to the opinions of your shareholders more intently.
- Taxation. Shareholders only need to report their business income and loss on personal tax returns. Many shareholders may also have the option to deduct 20 percent of their business income on their tax returns. You can also write off losses on your personal tax return. Tax is also filed annually rather than quarterly.
- Ownership. All shareholders have equal rank in an S corp.
- Limited liability. Limited liability is offered to all employees, stakeholders, and the management team.
- Losses. Shareholders may absorb corporate losses.
- Employment tax. Owners of the S corp may enjoy lower self-employment tax.
Cons of S Corp
- Paperwork. There is more paperwork involved in filing articles of incorporation, such as Form 2553. There may also be additional state-specific requirements.
- Taxation. S corps are more heavily scrutinized by the IRS. If a mistake is found, then the S corp status may be canceled.
- Ownership. Because S corps are more closely monitored by the IRS than C corps, any small mistake could lead to trouble for corporations. S corps must abide by the following rules: only have up to 100 shareholders, and shareholders must be U.S. citizens or residents. Not following these rules may have grave consequences for the S corp.
- Stock. There is only one type of stock option.
- Raising equity. It can be more difficult to raise equity in an S corp than it is in a C corp.
- Structure. S corps have a more rigid and expensive business structure.
Advantages and Disadvantages of C Corp
Just as there are benefits to electing an S corp vs C corp, there are advantages to selecting a corp over an S corp. First of all, C corps are easier to file for than S corps. There are also no restrictions on ownership. There can be an unlimited number of shareholders globally.
Shareholders also enjoy a 100 percent dedication for charitable donations (so long as you don’t exceed 10 percent of your company’s income). While C corps are subject to double taxation, the 2017 Tax Cuts and Job Act capped C corp taxes at 21 percent of shareholders globally.
Pros of S Corp
- Paperwork. There is a lot less paperwork to file for a C corp, since you are given the status of C corp as the default.
- Taxation. Charity contributions are 100 percent deductible, so long as the donation doesn’t exceed 10 percent of the company's income. Employees may also enjoy deductions for health insurance.
- Ownership. There are no restrictions on ownership. It is also easier to transfer ownership to another entity in a C corp than it is to in an S corp. It is easier to sell stock to investors because there is no limit on the amount of shareholders a C corp can have.
- Limited liability. Limited liability is offered to all employees, stakeholders, and the management team.
- Raising equity. It is easier to raise equity in a C corp than it is in an S corp.
- Stocks. C corps can issue more than one type of stock option: common stocks and preferred stocks.
Cons of C Corp
- Formation. While a C corp is the default status, it does not mean that it is the right structure for everyone. This structure may limit growth opportunities. C corps are generally the better option for larger companies.
- Taxation. One of the biggest downfalls for C corps is double taxation. The company’s revenue is taxed, and then dividends that shareholders receive are also taxed. Double taxation can then cut overall earnings.
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 C 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 the 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.
Now that you have a good grasp on the difference between an S vs C corp, let’s also review the other types of corporations. Below are the five different types of corporations and business structures that you may want to consider when you create a corporation for the first time.
B corporations exist to provide benefits to society. Typically, they are not solely profit-driven but focus on social and environmental good.
A closed corporation is not publicly traded but owned by limited shareholders.
A nonprofit corporation operates for other purposes other than to make a profit. These corporations are still incorporated under state and federal law.
Limited Liability Corporations (LLC)
An LLC is a business entity defined as its own legal organization. There are two types of LLCs: single-member LLCs (owned by one person) and multi-member LLCs (owned by multiple people).
Limited Liability Partnership (LLP)
A partnership is created when two people work on a business together. You can form a partnership without much planning or intent to start a business. There main difference between an LLC and an LLP is liability. In an LLC, owners are liable for the company’s actions, whereas in an LLP, partners are liable for their own actions.
Now that you’re equipped with understanding the difference between an S and C corporation, you are ready to choose your business structure.
If you need additional help understanding the difference between an S corp or C corp, post your legal needs on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers on 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.
Choosing between an S corp vs C corp can be difficult, but informing yourself can make the decision easier. Some key questions to ask yourself include:
- What tax implications of each structure fit my business?
- What is my long-term business plan?
- Which structure offers more flexibility to my business in terms of ownership and management?
- How much paperwork and administrative maintenance does each require to fit the amount of time I have?
- How much can I afford in terms of necessary startup and filing costs?
- Are there any other potential legal ramifications that I should consider when selecting between an S corp and a C corp?
If you feel like you’ve chosen the wrong type, there’s also the option of converting an S corp to a C corp.
Want to know how an S corp stacks up against an LLC chart? Check out our article on everything you need to know about S corps vs LLC charts.