What is S Corp and C Corp: Everything You Need to Know
What is S corp and C corp? An S corp is tax classification that the IRS gives a corporation, and a C corp is a standard legal entity created through the registration of articles of incorporation.3 min read
2. Corporate Taxation
3. S Corp Restrictions
What is S corp and C corp? An S corp is tax classification that the IRS gives a corporation, and a C corp is a standard legal entity created through the registration of articles of incorporation. In essence, a C corp is a default legal entity that small businesses can use. A C corp is the starting tax corporate entity, unless you choose to add an S-corp tax classification to the business. A C corp is also the most common corporate entity type in the United States.
Under a corporate structure, shareholders retain control over various policy matters, but directors largely manage the business itself. Directors are elected by shareholders. Moreover, directors elect officers who oversee various aspects of the business. Officers consist of the following:
On the other hand, an S corp is just a slight differentiation of a C corp, but it comes with special tax benefits bestowed by the IRS. The S corp gets its name from Subchapter S code of the IRS.
An S and C corp are similar in the following ways:
- Liability Protections: Shareholders enjoy certain liability protections, safeguarding their personal assets from court judgments in the event of a lawsuit. In other words, creditors cannot petition for a shareholder’s assets, such houses or cars, to satisfy business debts.
- Distinct Entities: S and C corps form separate entities from the shareholders.
- Perpetual Existence: S and C corps exist in perpetuity, even if an owner leaves or dies.
- Document Filings: Creation documents must be registered in the state where the business will be located. The main document you’ll need for registration is the articles of incorporation.
- Management Structure: Both entities consist of officers, directors, and shareholders. In addition, distributions and profits are dispensed to shareholders based his or her share in the business.
Both corporate entities must also adhere to various formalities in the form of:
- Stock issuance
- Creating bylaws
- Holding directors and shareholder meetings
- Submitting annual reports and paying fees
Failure to follow the aforementioned mandates could result in liability protection losses or dissolution of your business.
When it comes to taxes, choosing the right tax structure can make a huge difference in your business operations. Under a corporate system, you would file Form 1120 to report business income. Moreover, C corps face double taxation, where the business itself must pay business income taxes, and shareholders must pay separate taxes from dividends they receive when filing individual tax returns. Also, another C corp drawback is that shareholders cannot write off business losses on personal income statements.
S corp business entities abide by pass-through taxation, which is a method where losses and profits flow from the business to shareholders. Owners can then report such information on their tax returns and pay taxes accordingly.
For instance, you are the sole shareholder of a C corp and made $100,000 in profit. Moreover, the C corp would pay 28 percent in corporate taxes, amounting to $28,000. This leaves you with $72,000 in dividends, and you would pay additional personal taxes on that income.
- Note: S corps do not pay business income taxes.
If you own an S corp, on the other hand, you would pay no business income tax and get the full $100,000 in the form of a dividend. From there, you pay a 20-percent personal tax ($20,000), leaving you with $80,000 to keep without paying additional taxes. This amounts to $28,160 more than if you remained under a C corp.
S corps must submit an 1120S instead of an 1120, but the business does not have to pay corporate taxes.
S Corp Restrictions
S corps may offer tax savings, but you must be aware of the various restrictions:
- S corps cannot over 100 shareholders
- Shareholders must be U.S. citizens or permanent residents
- Other entities cannot own S corps, such as other corporations or LLCs
- S corps may only have one stock type (no tiered stock allowed)
C corps offer greater flexibility as your business grows while offering additional leeway if you wish to sell your business in the future. Further, C corps allow non-resident shareholders to own shares, and you may offer different stock classes to attract more investors. Additionally, you would fare better under a C corp if you want to raise investment capital faster, and C corps permit unlimited shareholders.
What is S corp and C corp? To learn more, submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s attorneys will give you greater insight into the benefits and drawbacks of S corps and C corps based on your goals and unique circumstance. Moreover, they will help you maintain your corporation so that it can remain compliant under IRS and state guidelines.