S Corps vs C Corps: Everything You Need to Know
Knowing the difference between S Corps vs C Corps can be tricky. In order to know the difference, however, you should recognize what exactly is a corporation.3 min read
Knowing the difference between S Corps vs C Corps can be rather tricky. In order to know the difference, however, you should recognize what exactly is a corporation.
Understanding Corporations Further
Corporation owners are called shareholders, and they choose directors (from the pool of shareholders) to command the running of business operations. Shareholders control policies regarding the company, but business issues are decided by the board of directors (selected by shareholders) who leave everyday business operations to the officers they hire.
Corporation profits or dividends are paid to shareholders based on the number of shares each shareholder owns. Corporation shareholders do not assume personal liability for business debts.
To form a corporation, you need to prepare a document called the articles of organization, which need to be filed with the state.
If a business doesn't comply with corporation requirements (detailed below), personal liability protection may be lost and the corporation may be dissolved. Normally, the assets of the corporation are the only assets that can be used to pay back corporate debts.
S Corporations vs C Corporations
A C corporation is the most common business type of corporation in the United States and is the default corporation formation.
An S corporation is intentionally elected to achieve a special tax status with the IRS and is named an S corporation as it falls under the S subchapter of the Internal Revenue Code.
You choose an S corporation in the formation stages by filing Form 2553 with the IRS, assuming you've met all the S corporation guidelines. New businesses have 75 days after formation to decide if they'll elect to be an S corp.
In terms of structures, both corporation types are the same. The shareholders own the business and make some decisions, as do the board and officers. In addition to receiving the same liability protection, they both need to follow documentation and compliance rules. This means filing articles of incorporation, issuing stock, paying administrative fees, and holding shareholder meetings.
A corporation can be taxed as a C corporation for many years before changing to an S corporation. The only thing to be wary of is paying the built-in gain tax from converting from an S corp to a C corp. Businesses electing to be an S corp from the outset avoid this situation.
S Corporation vs. C Corporation: Similarities
Many similarities exist between an S corporation and a C corporation.
- Limited liability protection is available for shareholders (owners).
- Both types of corporations are separate legal entities created by filing documents (articles of incorporation) with the state.
- Each state has its own rules regarding corporation structuring, but such rules usually include filing articles of incorporation, creating organizational resolutions that set the rules, appointing a board, issuing stock, and writing corporation bylaws.
- Both follow the same internal and external formalities and obligations, which includes bylaw creation, shareholder meetings, annual report filing, and fee remittance.
- Both corporations have "perpetual existence." If the original owner passes away or leaves the business, the corporations still exist in perpetuity.
S Corporation vs. C Corporation: Differences
The biggest differences in S corps vs C corps is regarding taxes.
- C corporations file a Form 1120 and pay taxes at the corporate level and are double taxed if income is distributed as dividends to owners, which also get taxed at a personal level.
- S corporations are pass through-through entities, with no income taxes paid at the corporate level. The profits/losses are passed onto the individual who then report the income on their personal tax returns.
- S corporations have more restrictions on ownership. They're limited to 100 shareholders who must be US citizens/residents and can't be owned by a C corp, LLC, partnership, or most trusts.
- C corporations can have a wide variety of stock classes, whereas S corporations are limited to one class, meaning they also have equal voting rights.
- C corps are able to divide their voting rights based on different stock classes. In general, early owners and founders have the most voting power.
C corporations are generally more flexible for businesses who plan to grow, expand, or possibly be sold down the road. In general, C corporations find it easier to raise money.
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