What Is the Difference Between C Corp and S Corp?
The main difference is that S corps have pass-through status. This status enables S corps to save on federal taxes.3 min read
What is the difference between a C corp and an S corp? The main difference is that S corps have pass-through status. This status, which C corps don't have, enables S corporations to save on federal taxes by waiving the requirement to pay federal corporate tax. S corps also differ from C corps in that S corps are prohibited from having more than 100 U.S. shareholders or having corporate shareholders. In addition, S corps can only have one type of stock.
C Corps and S Corps: Why Are They Different?
S corp status was designed for small corporations to enable them to save on taxes. This tax status gives small businesses pass-through tax treatment, which makes it possible for the S corporations to avoid double taxation by the IRS. Therefore, efforts are made to preclude bigger corporations from accessing the same benefits. Some of the major differences between C corps and S corps are:
- Taxation. S corporations do not pay IRS corporate tax. Although they file tax returns using IRS form 1120S, the return is for informational purposes, and the IRS does not collect the tax. C corporations, on the other hand, file and pay corporate tax on the corporation's profits using IRS Form 1120.
C corporations have an advantage over S corporation in the taxation of fringe benefits. When a C corporation gives fringe benefits such as medical and life insurance to its employee-shareholders, the corporation can deduct the value of those benefits from the taxes. This is done if the corporation extends those benefits to 70 percent or more of its employees. Most S corporations cannot claim this deduction unless the employee in question owns 2 percent or less of the S corporation.
At the state level, most states do not require S corporations to pay state corporate tax, which is normally a requirement for a C corporation.
- Shareholders. S corporations are not allowed to have more than 100 shareholders, but C corporations can have any number of shareholders. While S corporations are only allowed to have U.S. citizen or U.S. resident shareholders, there are no residency or nationality limitations on C corporation shareholders.
S corporation stock cannot be held by corporations, LLC, business trusts, or IRAs. All these entities can be shareholders of C corporations. These limitations on S corporation ownership make the S corp an undesirable investment for many investors.
- Stock. While C corporations can have a variety of stock types, S corporations cannot have more than one type of stock. When an S corporation is giving out earnings to its shareholders, the distribution must strictly be based on the number of shares a shareholder has. This limitation can hamper the corporation's efforts to get investors. C corporations have the freedom to distribute dividends using other criteria.
- Types of Investments. While C corporations can invest freely, and they won't be penalized if their income comes from passive sources, S corporations are not allowed to be passive businesses. An S corporation which earns more than 25 percent of its gross receipts from passive sources will be required to pay corporate tax on the passive income. Additionally, if an S corporation gets more than 25 percent of its income from passive sources for three years in a row, the IRS can terminate its S corp treatment. Limitations on passive income do not apply to the typical C corporations, and they make S corporations unsuitable for real estate holding and investment businesses.
- Types of Businesses. Banks, insurance companies, Domestic International Sales Corporations, and former Domestic International Sales Corporations cannot file as S corporations. All these business types can file as C corporations.
- Limitations on Filing. S corporation tax treatment is not available to businesses that have lost S corp treatment in the past five years. There are no such limitations on C corp treatment.
- Salaried Employee-Shareholders. S corporations are required to pay their employee-shareholders a reasonable salary. In an effort to prevent S corp employee-shareholders from evading payroll taxes, the IRS enforces this rule vigorously. C corps, on the other hand, can decide not to pay employee-shareholders a “reasonable” salary or any salary at all.
A good tax lawyer in your state can help you to weigh the pros and cons of C corps and S corps. If you need help with C corps and S corps, 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.