All You Need to Know About S Corp and C Corp

By Oran Yehiel, CPA (MBA) · Updated March 29, 2022  

S Corp vs C Corp

Starting a business may seem like a pretty straightforward process.

But in reality, there are a lot of factors to consider and choices to make, regardless of the industry.

While this is not meant to discourage anyone who is looking to dabble their toes in the start-up or entrepreneurship space, one needs to be aware of all of the requirements when it comes to setting up one’s own business, especially the legal requirements.

Keeping that in mind, here we are going to take a quick look at what it means to establish a C Corporation or an S Corporation in your state.

Despite its importance, surprisingly, this is one area that does not get much attention. 

The choice of entity type, as in, C Corp vs S Corp, has a huge impact on multiple aspects of your business. 

This may range from financing to taxes to business growth and the strategies that can be used to reach your business goals.

Seeing the importance of choosing the right corporation for your business entity, it pays to know the advantages and disadvantages of your options before you go ahead and make a decision.

Obviously, whether you go with a C Corporation or an S Corporation, the choice you make should always suit the unique needs and requirements of your business in terms of scalability, goals, and profitability.

Both business structures get their names from the parts of the Internal Revenue Code that they are taxed under.

C Corporations are taxed under Subchapter C while S Corporations are taxed under Subchapter S. Both types of corporations tend to offer financial protection.

In other words, if you incorporate a business, creditors can’t seize personal assets in order to pay off any business debts.

Similarities between C Corp and S Corp

In case you were wondering, there are a few similarities that are shared by both C Corporations and S Corporations. The following are some of them:

  • Their structure – In both S Corps and C Corps, there are directors, officers and shareholders. The shareholders are basically the owners of the corporation; however, the corporation owns the business. The shareholders elect the board of directors. The board oversees and directs corporation affairs and decision-making but is not responsible for day-to-day operations. The board elects the officers to manage daily business affairs.
  • Both are considered as separate legal entities - Corporations (S Corps and C Corps) are considered as separate legal entities that are created only by a state filing.
  • Limited liability protection - Corporations offer limited liability protection, so shareholders (owners) are typically not personally responsible for business debts and liabilities. This is true whether it is taxed as a C Corporation or an S Corporation.
  • Documentation filing – Documents filing, also known as the Articles of Incorporation or Certificate of Incorporation, need to be filed with the particular state that the company is going to be located. The filing remains the same for both S Corporation and C Corporation when it comes to taxes.
  • Corporate formalities – Under the law, every corporation is obligated to follow the internal and external corporate formalities and obligations. These include bylaw adoption, issuing of stocks, shareholder and director meetings, managing registered agents and office, the filing of annual reports, and payments of annual fees. Also, state corporation laws make no specific distinctions between S Corporations or C Corporations as far as compliance responsibilities go.
  • Tax Advantages – While back in the day, S Corp was the go-to choice for its tax exemptions, things have changed drastically over the past few years. For instance, if a company earns $100,000, the C Corp would be required to make a payment of corporate income tax on the money. If $50,000 was paid in dividends, or as a salary, and payment on income tax on that money. But, in the case of an S Corp, the $100,000 that was earned would be considered a personal income. Rather than paying corporate income tax, the individual would have to pay personal income tax, and if they take out their share as dividends, then they would also not have to pay Social Security tax. Now, according to the new law, C Corporations have a flat 21% tax rate, which also makes them an attractive option for those who are looking to start a corporation. If you own an S-corporation, you get to write off 20% of all business income on Form 1040.

Now that you know about some of the similarities between C Corp vs S Corp, it’s time to take a look at how you can file for either an S Corporation or a C Corporation in your state.

Becoming a C Corporation (C Corp)

 The truth is that you cannot form or become an S Corp or a C Corp, for that matter.

Forming a corporation is achieved by simply filling out a document called the Articles of Incorporation or Certificate of incorporation, depending on which state you’re in. 

Of course, you will have to choose a name for your business along with the corporations registered agent. 

Both of these names also have to be included in the Articles of incorporation.

Once the incorporation process is completed, the individual is also required to fulfill other requirements as well.

These requirements include, but aren’t limited to, adopting bylaws and also organizing a meeting with shareholders and directors, along with issuing shares of stock. 

Another important aspect of a corporation that you need to be privy to is that the corporation is going to be taxed under Subchapter C unless you qualify for and elect to be taxed under Subchapter S.

Becoming an S Corporation (S Corp)

Once you become a corporation and are considered to be a corporation by filing your Articles of Incorporation with the state where you live, you also need to file Form 2553 with the IRS.

This is mandatory if you are looking to make sure that your corporation is taxed under Subchapter S.

According to the instructions by the IRS, which could be a bit complex for some folks requires that an election is considered effective in the current tax year only if Form 2553 is completed and filed.

This should be kept in mind with filing under this option. Also, other important IRS guidelines to keep in mind include;

  • An election made after the 15th day of the 3rd month, but before the end of the tax year.
  • Any time before the 16th day of the 3rd month
  • Any time during the preceding tax year. (Or an election made before 2 months and 15 days after the beginning of a tax year that is less than 2½ months long).

C Corp, S Corp, and Taxes

One of the biggest differences between both C Corporations and S Corporations is taxes.

For instance, while C Corporations pay tax on their income, plus you pay tax on whatever income you receive as an owner or employee. 

An S Corporation doesn’t pay tax. Instead, you and the other owners report the company revenue as personal income. 

Owners only need to report business income and loss on personal income tax returns. Most S Corps can deduct up to 20% of their business income on their personal tax returns.

On the flip side, with C Corps, you can deduct 100% of your charitable contributions and donations on your corporate tax return, as long as the donations don’t exceed 10% of your company’s income.

What is the Best Option for Small Business?

When it comes to choosing between C Corp vs S Corp, one of the most pressing questions that people have got to answer is, what is the best option for small business owners?

This is a great question to ask for anybody who is looking to choose between C Corps and S Corps mainly because while C Corporations are the default company when it comes to filing statue, it is not necessarily the right option for all business types.

This is why it is so crucial for business owners to ask the right questions before choosing C Corps or S Corps. Some of those questions are as follows;

Are there shareholder limitations?

It is true that some businesses just aren’t cut out for large expansions, while some businesses just want to remain where they are in terms of size.

Because S Corporations are limited to 100 shareholders, and they have to be U.S. citizens, business owners may feel like that’s enough to set up a company, and they would be wrong.

This is why it is important to keep in mind that despite having a 100 shareholder limit, S Corporations tend to put more emphasis on shareholder input.

On the other hand, some business owners may prefer smaller setups, which is where one should consider filing their business as a C Corp, especially if they think that their company may face significant growth further on down the road.

Is double taxation really worth it?

The biggest differentiator between S Corps and C Corps is that the latter faces corporate tax.

In other words, this means that if an owner is comfortable with getting taxed at the corporate level and then again at the personal level, then they should definitely not have any issue with becoming a C Corp. 

However, if the owner prefers to save on corporate taxes and handle profit and losses through their personal income tax, then S Corps is the way to go.

What about security?

As you may already know, the default filing for corporations is C Corps, but there is also an extra layer of paperwork that also needs to be completed if you are opting for an S Corp.

Also, becoming an S Corporation will mean that the owner is going to be subjected to an extra-careful watchful eye from the IRS. 

In other words, owners of S Corps have to be certain that they keep all of their records clean and easily available when required by the IRS since even the slightest mistake such as going over the 100 shareholder limit could result in the owner losing their coveted S Corp status. 

For those business owners who are under the impression that the IRS is always over your shoulder and don’t want to get into any unwanted trouble, then S Corps is the way to go.

What are the rules for getting acquired?

One of the most pressing questions that business owners who are at the crossroads and have to choose between C Corp vs S Corp have to answer is – what are the implications if a business wants to get acquired in the long run?

This is another interesting question that is important to answer when choosing between C Corporations and S Corporations. 

This is where it is important for business owners to know the basic differences between C Corp vs S Corp. 

For those who feel that getting acquired is over the horizon, then they may want to go with a C Corp, which will be more in tune with their specific requirements. 

This is mainly because of the fact that C Corporations have the ability to be owned by other types of companies. 

This makes acquisitions much easier in the long run for small business owners and large businesses alike. 

Additionally, business owners also have the choice of having as many owners as they like, along with multiple different classes of shareholders as well.

Are there any other options?

This is another great question that is asked many times, especially for those who are new to C Corp and S Corp, and do not really know the difference between the two.

While this question is usually the result of business owners being intimidated by the huge paperwork that’s required by C Corps and S Corps, it is important to know the answer all the same.

For those business owners who feel like neither a C Corp nor S Corp works for their business needs, then the good news is that there are other options available when it comes to setting up one’s business.

For example, business owners can set up their business as an LLC, sole proprietor, partnership or a trust/estate. 

Keeping that in mind, business owners that are planning on being the only person in the company might benefit from setting up their company as a sole proprietor or LLC. 

However, they will have to keep in mind that as with other options, such as the sole proprietor, there’s virtually no distinction between the owner and the company. 

This means, if the company accrues any debt, then the owner is going to be held personally responsible for paying that debt off. And if you don’t, your assets could be seized to pay for that debt.

When it comes to the other option, which is establishing your business as an LLC, then the owner’s liability is limited to the investment that they have put into their business.

In other words, incorporating as an LLC protects business owners against any and all potential lawsuits, along with providing them with a far better opportunity to get the finances that they require for future endeavors. 

However, it is important here to note that there is going to be much more paperwork involved in becoming an LLC, as compared to incorporating as an S Corp or C Corp. But, for many business owners, the hard work pays off in the long run.

At the end of the day, the way a business owner plans on running their business mainly depends on the type of company that they want to run in the first place.

This also includes their vision for the future of their business and their level of comfort when it comes to dividing ownership of their business or when it comes to paying taxes. 

At the end of the day, it pays to make sure that you know all there is to know about C Corp vs S Corp, before you make a decision that can change the outcome of your business forever.

Since an S Corp is often not available to large corporations, those with a lot of start-up capital and large ambition, or those planning to sell stock globally.

This is why C Corp is more popular with larger companies because of the greater flexibility to raise capital. 

While it is true that each entity type offers a unique blend of legal and tax implications, it is equally important to make sure you get it right the first time when it comes to incorporating your business.

Disadvantages of C Corp and S Corp

There are two sides to every coin. While both C Corporations and S Corporations come with their fair share of advantages, there are a few disadvantages as well that one needs to be aware of before they sign on the dotted line.

The following is a quick break down of some of the most glaring disadvantages of both C Corporations and S Corporations ownership that you need to know about before filing for a corporation.

Let’s begin with C Corporations.

C Corps don’t have ownership restrictions or limits on classes of stock.

However, this also means that one needs to keep their business up-to-date by managing it correctly. 

If necessary, they will have to issue stock to shareholders and hold shareholders and board of directors meetings. 

Along with that, where applicable, owners are also required to pay any necessary fees to maintain their C Corp ownership status.

On the flip side, those who choose S Corporations also have their fair share of challenges.

For instance, since S Corps are inherently more heavily scrutinized by the IRS, breaking any rules could mean you lose your S Corp status. 

A good example of this can be given as the following. Owners are forced to stay within the 100 shareholder limit.

Not only that, but all of the shareholders need to be U.S. residents.

It doesn’t end there either; S Corps are only allowed one class of stock; on the other hand, C Corps get to enjoy multiple classes of stock.

This could be a downside, especially for those who are looking to scale and grow their business.

Additionally, S Corps can’t be owned by other S Corps.

This also goes for LLCs, C Corps, and even trusts.

Again, this could be a deal-breaker, especially for those companies that are looking to get acquired in the future.

Final Thoughts

Making the right choice when it comes to C Corp vs S Corp is crucial to the future of one’s business.

In fact, it wouldn’t be wrong to say that going with C Corp vs S Corp can either make or break your business. While the two are easy to make, they also come with their fair share of advantages and disadvantages that you should be aware of before you sign on the dotted line.

That being said, there are more corporations today than ever before, and there’s a reason for that.

Not only is establishing a corporation now easier than ever before, but there are also quite a few benefits that are provided on the federal level, which makes both C Corps and S Corps an attractive option for investors and business-minded folks who want to try their hand at starting a company.

S-Corp shareholder limitations may be beneficial for businesses who want to stay small and closely held.

On the other hand, C-Corp status allows for large-scale growth and the flexibility to sell the company in the future.

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