What is a C corporation vs an S Corporation?
A C Corp has little restrictions on ownership and stock transfer. The S Corp was established to help qualified small corporation owners save on federal taxes.3 min read
What is a C corporation vs an S corporation? A C corporation is the traditional corporation type, which has little restrictions on ownership and stock transfer. The S corporation, on the other hand, is a relatively new corporation type that was established to help qualified small corporation owners save on federal taxes. The S corporation entity type is only available to corporations that have no more than 100 shareholders and who are individual U.S. citizens or residents.
C Corporations Versus S Corporations: The Similarities
Because S corporations and C corporations have the same foundation, they have a number of similarities, including the following:
Formation: Both corporations are formed by filing with the secretary of state. The initial procedures of formation are practically identical and involve:
- Reserving a name
- Appointing a registered agent
- Appointing a board of directors
- Filing the certificate of incorporation
- Holding the first board of directors meeting
- Adopting corporate bylaws
- Issuing stock
- Applying for an EIN.
Operational requirements: Both corporation types are required to hold a formal board of directors meetings and have the same recordkeeping requirements.
Limited liability protection: Both corporation types give limited liability protection to the shareholders.
C Corporations Versus S Corporations: The Differences
C corporations and S corporations have a number of differences:
- Tax Status. Unlike C corporations, S corporations have pass-through tax status. This means the IRS does not require S corporations to pay income tax. Although S corporations file tax returns to the IRS using Form 1120S, any income is passed through to the individual shareholders for tax purposes. The S corporation also files a copy of all the shareholders' Schedule K-1 forms to the IRS. C corporations, on the other hand, do not have pass-through status and must pay corporate tax to the IRS. This is in addition to personal income tax on the dividends of the individual shareholders. C corporations file and pay corporate tax returns using IRS Form 1120.
- Taxes on Fringe Benefits. Apart from corporate tax, C corporations and S corporation pay more or less the same taxes. C corporations have the advantage that they can deduct the value of benefits from employee-shareholder benefits. For the C corporation to be able to claim the deductions on fringe benefits, it must extend these benefits to 70 percent or more of its workforce. This is not possible for most S corporation shareholders. Unless an S corporation employee-shareholder owns 2 percent or less of the corporation's stock, the S corporation cannot deduct the value of such benefits from taxes.
- Ownership. S corporations are not allowed to have more than 100 shareholders, but this is allowed for C corporations. S corporation shareholders must be U.S. residents or U.S. permanent residents, but C corporations can have shareholders from around the globe.
S corporations are prohibited from having nonindividual shareholders. This includes corporations, business trusts, LLCs, and Limited Liability Partnerships. C corporations do not have these limitations.
- Types of Businesses. The law prohibits banks, insurance companies, and Domestic International Sales Corporations, or former Domestic International Sales Corporations from filing as S corporations. All these business types can file as C corporations.
- Stock. C corporations can have a number of classes of stock and might give out dividends depending on the type of stock. S corporations are only allowed to have one type of stock. The basis for giving out earnings should be the number of shares a shareholder has.
- Passive Income. S corporations are discouraged from having passive ventures such as investment and rental businesses. An S corporation will be required to pay taxes on any income it gets from passive ventures if the passive income exceeds 25 percent of the corporation's total gross receipts. An S corporation whose passive income exceeds 25 percent of its total income for three years in a row will automatically lose its S corp treatment. These limitations do not apply to C corporations.
The C corporation entity type favors big corporations that have corporate and international investors. The taxation status is also ideal for startups that have the goal of growing rapidly by selling shares. The limitations of S corporation mean this entity type is only available to small business with a few U.S. shareholders, who have little desire to sell their stock. A good tax lawyer can help you to decide the right type of corporation for you.
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