S corp vs. C corp at a glance
An S corp and C corp share a number of similarities. They are both types of corporations recognized by the IRS. They can also both raise funds by issuing stock to shareholders.
However, S corps are pass-through entities, meaning profits and losses pass through the business and to its shareholders, who must report them as income on their personal tax returns. A C corp, in contrast, is completely separate from its shareholders and must pay its own taxes. Then, when profits are dispersed to its shareholders as dividends, they too must pay personal income taxes on those profits.
Both types of corporations have pros and cons that businesses should understand before deciding on the best structure to meet their business needs.
What is an S corporation?
A business created as an S corp must meet all federal guidelines for an S corp and file Form 2553.To be eligible for S corp election, the business must:
- Be a U.S.-based business.
- Have no more than 100 shareholders.
- Have only qualified shareholders, meaning shareholders must be individuals, estates, organizations or certain trusts.
- Have no nonresident alien shareholders.
- Issue only one class of stock.
- Not be a bank, thrift institution, insurance company or domestic international sales corporation (DISC).
- Adopt a tax year ending on December 31, a natural business year or an ownership tax year.
- Elect to become an S corp no more than two months and 15 days after the beginning of the tax year in which the S corp election will take effect or any time in the year prior to when the election should take effect.
An S corp is a business structure and tax election that allows the business to pass through all its income as well as any deductions, credits and losses to its shareholders. Shareholders must pay business taxes on their personal income tax returns. In doing so, the business does not have to pay corporate taxes in addition to member taxes, thereby avoiding the “double taxation” corporations endure.
This provides shareholders with a number of tax benefits. S corp shareholders are considered employees, which means they must only pay a portion of their Medicare and Social Security taxes, while the S corp covers the rest. In addition, any dividends that are issued to shareholders are taxed at a lower rate than income taxes, if at all. Shareholders can also claim business losses on their personal tax returns, helping to lower their tax debt.
However, S corporations have limitations that other types of business structures may not. For example, they can only have 100 shareholders while C corps can have unlimited shareholders. They can also only issue one type of stock, while C corporations can issue more types.
In addition, because an S corporation can divide shareholder compensation between wages (which require Medicare and Social Security payments) and dividends (which are often not taxed at all), the IRS closely scrutinizes S corps to ensure shareholders are receiving reasonable wage amounts for their services.
S corp pros and cons
Pros:
- Can issue stock to shareholders.
- Are taxed as pass-through entities to avoid corporate double taxation.
- Must follow fewer compliance regulations than a C corp.
- Must pay lower taxes on dividends.
- Members are not held personally liable for business debts, such as those arising from a lawsuit.
- Members can claim business losses on personal tax returns to lower tax debt.
- Interests can be freely transferred among members.
Cons:
- Can only have 100 shareholders.
- Must only have U.S. citizens or residents as shareholders.
- Can only issue one class of stock.
- Endures greater IRS scrutiny regarding shareholders’ wages versus disbursements.
What is a C corporation?
A C corp is a business structure that offers limited liability protection to its shareholders. The company is completely separate from its shareholders. As such, it is held accountable for paying its own taxes, defending itself against lawsuits and paying business debts. This separation also means that, if a shareholder — even a key shareholder — leaves, the corporation remains intact and can operate in perpetuity.
C corporations are not managed by their shareholders. Instead, a board of directors appoints officers to manage the business’s operations. However, the board of directors is appointed by a C corporation’s shareholders. Shareholders also have the right to vote on major C corporation changes, but their management roles end there.
A corporation can issue multiple classes of stock to its shareholders. In turn, its shareholders can freely retain or sell those shares at will. There are few restrictions on who a C corporation’s shareholders can be or how many shareholders a C corp can have. Some corporations, for example, can invest in a C corporation but not an S corporation.
However, C corporations have disadvantages that S corporations do not. They must comply with complex management rules. For example, shareholder and director meetings must be held and structured. All shareholders and directors must be given advance notice of such meetings and meeting minutes must be recorded.
They are also subject to “double taxation.” While profits and losses pass through an S corp entity to shareholders’ personal income taxes, C corp taxes must be paid at the corporate and shareholder level. First, the corporation pays taxes on profits earned. Then, those profits are passed along to its shareholders in the form of dividends. Those dividends are then taxed as personal shareholder income.
C corp pros and cons
Pros:
- Can issue multiple classes of stock.
- No restrictions on the types of stock that can be offered.
- No restrictions on the number of shareholders.
- Shareholders don’t have to be U.S. citizens or residents.
- Transferring shares can be done at will without the consent of other shareholders.
- Shareholders’ personal assets are protected from business debt.
- C corporation stocks can be traded on public stock exchanges.
- Attracts investors who cannot invest in S corps.
- Exists in perpetuity even if shareholders leave or pass away.
Cons:
- Complex management rules.
- Subject to “double taxation” at the corporate and individual shareholder level.
- Numerous compliance regulations to follow.
- A board of directors is required.
- Shareholders have limited power to manage the corporation’s operations.
Key differences: S corp vs. C corp
Understanding tax designations
S corps are taxed as pass-through entities. This means that all business income, losses, credits and deductions are passed through to the individuals who own the corporation and are then reported on their personal income tax statements. Since credits, losses and deductions also pass through, these individuals have a number of benefits from this corporate structure at tax time.
C corps are required to file their own tax returns. They are subject to tax at the corporate level. As dividends are dispersed to shareholders, shareholders also pay taxes on the amount they received on their personal tax returns. This double taxation occurs because the corporation is a completely separate entity from its shareholders. As a result, both the entity and shareholders are taxed when receiving income from the corporation.
Alternatives to consider
If neither a C corp or S corp seems quite right for your business, you may also consider exploring other business structures, such as a limited liability company (LLC), a sole proprietorship or a partnership.
- An LLC is a pass-through entity where members pay taxes on business profits and losses through their personal income tax filings. Unlike an S corp, an LLC can have unlimited members. And, unlike a C corp, it is quite informally run. Members create an operating agreement about how they wish to manage the LLC and can then implement their own management structure and rules.
- Sole proprietorship: Unlike an S corp and a C corp, this business structure does not require any filing to legally form. The sole proprietor must conduct business, pay quarterly estimated taxes on business earnings and report yearly earnings on their personal income tax returns. However, members are limited to one.
- Partnership: A partnership is a pass-through entity with two owners. Each member reports their share of profits or losses on their personal income tax returns. There are different types of partnerships, including a general partnership, limited partnership and joint venture. For example, a limited partnership allows owners to invest in the company and retain limited liability protection around their personal assets.
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Frequently asked questions (FAQs)
An S corp has a different management structure than a C corp. While a C corp has a board of directors that shareholders appoint to manage the operation, an S corp is managed by its shareholders. In addition, an S corp only issues one class of stock, while a C corp often issues multiple classes. Finally, an S corp can only have 100 shareholders, while C corps can have many more.
Whether a C corp or S corp structure is better for your business depends on your business’s goals. An S corp may have some tax and regulatory advantages, while a C corp may provide a heightened ability to raise capital quickly and operate globally. Define your business goals and then find out if a C corp or S corp is right for you by consulting a tax professional.
The owner of a C corp is not required to draw a salary. While many do draw a salary, especially in the beginning stages when they are doing all the work, some hire managers to manage the business for them and, at that point, stop taking a salary.
An S corp can be better for some small businesses. As a pass-through entity, it is not subject to tax at the corporate level, which can be an advantage for many small businesses. S corps also don’t require a board of directors like a C corp does. However, if you own a startup and are looking to eventually go public or raise capital quickly by issuing shares of stock, a C corp offers fewer restrictions on shareholder selection and number of shareholders, often allowing for faster fundraising initiatives.
