S-Corp or C-Corp for Small Business: Everything to Know
S Corp or C Corp is a question for entrepreneurs who are wondering whether corporate taxation may be the most- advantageous choice for their new LLC.3 min read
2. What Is an S Corporation?
3. Differences Between C and S Corporations
4. Electing S-Corp Status
S-corp or C-corp for small business is a question for entrepreneurs who are wondering whether corporate taxation may be the most- advantageous choice for their new limited liability company (LLC). This business entity has the flexibility to choose between several different tax treatments. If your LLC has one owner, called a member, you can opt to be taxed as either a corporation or a sole proprietorship. LLCs with more than one member can opt to file taxes either as a partnership or corporation.
With LLCs, S corporations, partnerships, and sole proprietorships, business income and expenses are reported on each member's individual tax return. This is called pass-through taxation and allows companies to avoid the double taxation that affects C corporations. With that entity, income is taxed when it is earned at the corporate level and when it is distributed to shareholders at the individual level.
What Is a C Corporation?
In the U.S., a C corporation is the most common type of corporation and is considered the standard entity for small businesses and the default form of incorporation. C corporations are owned by shareholders who own portions of the company known as shares. C corporations are legal entities independent of their owners and provide liability protection. This means that shareholders are not personally responsible for business debts and financial obligations.
While shareholders have influence over major decisions for the company, regular business issues are decided by a board of directors elected by the shareholders. C-corp officers, including the CEO, CFO, and COO, manage the business's daily operations.
To create a C corporation, you typically need to submit articles of incorporation to the secretary of the state where you plan to incorporate. Once established, this business entity must comply with requirements such as paying fees, issuing stock, and holding regular director and shareholder meetings.
What Is an S Corporation?
An S corporation has the same structure as a C corporation and also provides its shareholders with liability protection. Like a C corporation, it must meet certain management obligations. But while these entities are quite similar, it's important to consider the differences before choosing one or the other for your business.
An S corporation is treated as a pass-through tax entity and avoids the double taxation of C corporations. However, an S corporation is limited to 100 shareholders, all of whom must be U.S. citizens or resident aliens.
Differences Between C and S Corporations
Taxation is the primary difference between C and S corporations. C corporations must file Form 1120 to pay separate corporate taxes each year. If and when they distribute profits as dividends to shareholders, these funds are taxed again at the individual level. S corporations file only an informational annual return using Form 1120S and are not subject to corporate income tax. Instead, each shareholder pays individual income taxes on his or her share of profits and losses. Despite this tax benefit, however, C-corps tend to be subject to a higher level of oversight by the IRS.
In addition to the restrictions on the number of shareholders, S corporations have strict rules about who can own shares. Other corporations, most trusts, and partnerships are not eligible to be S-corp shareholders. S corporations can only issue one class of stock, while C corporations can issue many different stock classes. However, S corporations can have different voting rights for different shareholders.
C corporations are allowed to deduct the cost of employee benefits such as health and disability insurance as long as these benefits are provided to at least 70 percent of the company.
Electing S-Corp Status
A C corporation can become an S corporation by filing IRS Form 2553. For this election to be effective in the current tax year, the form must be successfully submitted before March 15 for calendar-year taxpayers and before the 16th day of the third month of the tax year for fiscal-year taxpayers. Elections made after this deadline will take effect in the subsequent tax year. In some states, you'll need to elect S-corp status on the state level as well as on the federal level.
If you need help with determining whether a C or S corporation is the right structure for your business, 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.