Whether to form an LLC, C corp, or S corp is a major dilemma business owners face at the time of incorporation. They are the three primary forms of incorporated business.

S Corporation and Its definition

  • An S corporation is so called because it is formed pursuant to Subchapter S of IRC or the Internal Revenue Code.
  • To form an S corporation, you must meet all the S corporation guidelines and file Form 2553 with the Internal Revenue Service (IRS).
  • An S corporation cannot have other companies and non-US citizens as its stockholders.
  • In case of startups, you can choose to have the S corp status before raising finance and revoke it at the financing stage.

When Is the Election in S Corp Considered Effective According to Form 2553?

  • You must apply for the S corp status before March 15th.
  • If you elect for S corp after March 15th, it will be effective from another tax year, unless you can establish a valid cause for delay in election.
  • In some states, you may also need to file a separate S corporation election with the state.

The Disadvantages of S Corporations

  • The number of shareholders in an S corporation cannot be more than 100. It cannot have a non-resident alien or other corporation as its shareholder.
  • An S corporation can have only one class of stock.
  • An S corporation cannot conduct certain types of businesses, like banking and insurance.
  • Compared to a C corp, an S corp has fewer options when it comes to offering employee fringe benefits.
  • An S corporation has to submit the details of taxable compensation of its employees.

Similarities Between S Corporation and C Corporation

  • A C corporation is a standard company, whereas an S corporation holds a special status from IRS for the purpose of taxation.
  • Both forms of corporation have limited liability protection; shareholders cannot be held personally accountable to settle debts and liabilities of the business.
  • Both of them are treated as separate legal entities from individual shareholders of the company.
  • Forming either of them requires filing Articles of Incorporation, which is also referred to as Certificate of Incorporation in some states.
  • In both the cases, shareholders are the owners and directors oversee the management.
  • Business formalities and procedures like issuing shares, holding director and general body meetings, adopting bylaws, and filing annual reports are same in both the cases.
  • Ownership transfer in both the cases is done by selling shares.

Differences Between S Corporation and C Corporation

  • Taxation is the major difference to consider while choosing between an S corporation and a C corporation.
  • C corporations are liable to pay taxes separately at the corporate level.
  • C corporations are often subject to double taxation. When they distribute their income as dividends (on which corporate income tax is already paid), the shareholders are again liable to pay personal income tax on the dividends they receive.
  • S corporations pass through their income to their shareholders. They file a return with the IRS but do not pay any income tax at the corporate level.
  • S corp shareholders include their share of company profits and losses in their personal tax returns and pay taxes at individual level.
  • C corp as well as S corp shareholders pay personal income tax on the salary and dividends they receive from the company.
  • Unlike C corporations, S corporations have certain ownership restrictions.
  • S corps cannot have other S corps, C corps, LLCs, partnership firms, and certain trusts as their shareholders.
  • Except for disproportionate voting rights, S corps can't have more than one class of shares. C corps do not have any such restrictions.
  • C corps are more flexible, and hence more suitable, if you plan on expanding ownership of the company.
  • C corps, unless they are small corporations, must follow accrual method of accounting. S corps, on the other hand, can follow cash method accounts unless they hold inventory.
  • Individual tax returns containing higher amounts of business income are more prone to IRS audit. Forming an S corp lowers this risk of audit since it files an informational return with the tax department.

Advantages of C Corporations

  • Investors prefer the C corp structure since it offers more protective measures and multiple classes of shares, including preferred shares.

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