S Corporation Versus C Corporation: Everything You Need to Know
Choosing an S corporation versus C corporation depends on several factors. 4 min read
Choosing an S corporation versus C corporation depends on several factors. The main difference between the two lies in how the corporation is taxed. Profits from a C corporation are taxed twice: once at the corporate level and then again on an individual level once they are distributed to shareholders. Profits from an S corporation are only taxed once, thanks to pass-through taxation.
Many small business owners get excited and have momentum when they're just starting but come to a stop when they realize they need to decide which business entity to be so they can make a profit. This decision should be made deliberately and carefully and reevaluated periodically. A corporation can be taxed as a C corporation for years and then decide to change to an S corporation.
Without a lawyer, it's easy to get lost in the process of choosing a business structure. A corporation should protect the personal assets of shareholders from liability. It should also separate personal finances and business. Corporations are allowed in every state in the United States and the District of Columbia. A corporation gets set up under the state law and is separate from the owners.
Since it's a separate legal entity, the assets of the corporation are used to cover corporate debts. Although there are a few exceptions, a shareholder generally isn't liable for any corporate debts. The shareholders' assets are also protected from any business creditors.
C Corporation: Background
Corporations are automatically C corporations unless they file to have S status. If no action is taken, the corporation is a C corporation. This is a standard type of business entity for smaller businesses. It's also what many people think of when they think of a regular business. The most common type of corporation in the United States is a C corporation. C corporations have liability protection whereby the shareholders are not liable for any business liability or debts.
C Corporation: Structuring Your Business
Once the legal name is chosen for the business, it should be filed with the Secretary of State. There will be a fee associated with this filing. Come up with the corporate bylaws and schedule a board of directors' meeting to discuss it with everyone in the corporation. Once the Secretary of State confirms the Articles of Incorporation have been accepted, the next step is to give stock certificates to the initial shareholders.
Next, apply for all business permits and licenses for the state and industry. Form SS-4 should be filed with the IRS in person or online in order to obtain an Employer Identification Number (EIN). The EIN is necessary even if no employees are hired. It will also be needed to open a business bank account or apply for smaller business loans. Your local and state government might have other ID numbers the business needs to obtain in order to operate legally.
S Corporation: Background
An S corporation is similar to a C corporation but with a small variation. S corporations are so called because the applicable law is found in Subchapter S in the first chapter of the IRS.
The IRS instructions say an election is only effective during a tax year if Form 2553 is filled out. The following requirements must also be met.
- The form must be filed before the 16th day of the third month.
- The form must be filed during the previous tax year.
An election that's made after the 15th day of the third month but before the tax year is over will be effective for the next tax year. If corporations operate on a different fiscal year, the form needs to be filed by the 15th day of the third month of the fiscal year. Some states may require a state-level S corporation election to be filed after the business is incorporated.
S Corporation: Structuring Your Business
Setting up an S corporation is similar to setting up a C corporation, as an S corporation is a tax election made after forming a C corporation. The following steps need to be followed for an S corporation:
- Pick the legal name for the business and file it with the secretary of state.
- File your Articles of Incorporation with the Secretary of State (a fee will come with this).
- Draft the corporate bylaws and have a board of directors' meeting.
- Hand out stock certificates to the initial shareholders once the Articles of Incorporation have been accepted.
- Apply for business permits and licenses for the state and industry.
- File Form SS-5 to get an Employer Identification Number.
- Use IRS form 2553 to elect to be taxed as an S corporation at the federal level.
- Follow any state requirements for S corporations.
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