C Corps vs. S Corps: The complete guide
As a business owner, you’ve probably heard of C Corps and S Corps. As you might expect, both of these business structures are corporations. But what’s the difference, and what does it mean for you as a founder?
Figuring out which structure is best for your business is an important step for any start-up. In this article, we’ll go over the differences between C Corps and S Corps and explain the implications for taxes, liability, compliance, and other key areas of your business.
What are C Corps and S Corps?
First, let’s go over the basics. A C Corp is the common name for the default corporation type under US law. If you incorporate a corporation in the US, it will be considered a C Corp unless you specifically request otherwise.
C Corps are responsible for corporate taxes on profits, and employees must also pay income tax on their own salaries. This is often known as double taxation.
S Corps, on the other hand, are corporations taxed as pass-through entities. In other words, the company’s profits and losses are passed onto shareholders, who are responsible for personal income tax. This allows businesses to avoid corporate income tax and double taxation, which could significantly lower their overall tax obligations.
How do I file as an S Corp?
If you want to pay taxes as an S Corp, you’ll need to file form 2553 with the IRS. You can learn more about this process in our guide to form 2553.
It’s important to note that both LLCs and C Corps can elect to file as S Corps. However, there are some limitations on which C Corps are eligible for S-Corp status. To qualify, your business must:
- Be a domestic corporation
- Have no more than 100 shareholders
- Have only one class of stock
- Have only “eligible shareholders,” as defined by the IRS (i.e. individuals, estates and certain tax-exempt organizations, rather than partnerships or other corporations)
- Not be a bank, insurance company or domestic international sales corporation
While double taxation sounds bad, the reality is that C-Corp status may lead to more favorable tax outcomes depending on your company’s circumstances. If you’re reinvesting most income back into the business, you may have little to no profits subject to corporate tax.
Additionally, S Corps are treated differently in different states. For example, Texas taxes S Corps the same as C Corps, while New York requires a separate state filing for S-Corp status at the state level. Make sure to check state regulations before making any final decisions.
What do C Corps and S Corps have in common?
Limited liability protection
As mentioned above, both C Corps and S Corps provide liability protection to their owners. This means that owners and shareholders cannot be held personally liable for financial losses or debts accrued by the business.
- On a related note, both C Corps and S Corps are separate legal entities from their owners. They can enter into contracts, sue or be sued, and complete other business activities in their own name.
Corporations, regardless of structure, must fulfill some basic compliance requirements in order to maintain their status.
- Holding initial and annual shareholder meetings, and keeping appropriate minutes
- Adopting bylaws
- Recording stock transfers, and keeping other business records
Where do they differ?
The most significant difference between C Corps and S Corps is in the way these two types of entities are taxed.
C Corps are subject to what is referred to as “double taxation.” Under the tax code, C Corps are required to pay taxes on any retained profits at the corporate level, as well as at the individual level in the form of income. Owners seeking to be paid through dividends will thus be stuck paying extra tax.
S Corps are still permitted to retain profits, but owners only pay taxes on the individual level. This is what’s referred to as a “pass through” tax structure: profits and losses are passed through the business to the company’s shareholders, and appear on their personal tax returns.
Shareholders and stock
This is where C Corps get their competitive edge. Unlike S Corps, C Corps can offer an unlimited number of shares to an unlimited number of shareholders, and thus have no hard limit on growth.
C Corps can offer stock options to employees, and deduct the cost of employee benefits from its taxable income. C Corps also benefit in their ability to issue multiple classes of stock, which grants even greater flexibility to business owners.
While S Corps can also raise capital by offering stock, there are limits. S Corps cannot have more than 100 shareholders, and cannot make an initial public offering (IPO).
Unlike C Corps, S Corps can only issue one kind of stock (voting and non-voting shares are permitted, however).
Both C Corps and S Corps have advantages and disadvantages. The structure that is best for your business depends on your unique needs and goals.
Because they allow for an unlimited number of investors, it’s more common for large businesses to be C Corps than S Corps.
But that doesn’t mean S Corps are never the right idea, or that organizing as an S Corp means your business won’t be able to grow at all.
Regardless of which you choose, be sure to be aware of the compliance requirements to make sure you don’t lose corporation status.
If you’re still feeling unsure, take Firstbase’s free survey to help figure out which company structure is right for you.