As an entrepreneur, you can choose to structure your business as a C Corporation or an S Corporation. The key difference between these 2 corporations is how they are taxed.
This C Corp vs S Corp review (see also LLC vs S Corp) will explain everything you need to know about them such as taxation, ownership, and shareholders’ rights differences so you can decide what’s best for your business - see also the best business ideas.
Corporations and LLC are formed by filing a document. Compared to LLC formation, the document needed to register a corporation is called articles of incorporation while for LLC is articles of organization. We also explained how to chose the best state to form your LLC and provided our detailed IncFile review, our Zen Business review, while we also reviewed Rocket Lawyer to give you the best possible business registration service.
C Corp vs S Corp - Which Is Better For You?
What is a C Corp?
A-C Corp or C Corporation is a legal entity in which the shareholders and the corporation pay tax. This means a C corporation pays corporate income tax plus its members or shareholders pay personal income taxes. Also, for more guidance on small business tax, see this article and for ways to fund it click here.
This is double taxation unless a C Corporation converts to an S corporation.
A-C Corp protects its owner’s from being sued in case the corporation fails to pay its debts.
Since it is a separate entity, it can make its own contracts, buy properties, be sued, invest funds, have obligations, liabilities, and all debts are its own. It can be a public or private corporation.
Directors make business Decisions
Shareholders own a corporation. They do not directly manage the corporation hence need to elect a board of directors to manage it. They make major decisions concerning the business.
Unlimited number of investors
There is no limitation of the number of shareholders that C corporations can have. This is not the case with S corporation which limits its members to 100.
This means that a lot of shares can be sold to interested investors thus raising a lot of capital for the C Corporation.
This comes in handy when the business wants finances for expansion or is in a financial crisis. Foreign nationals can invest in C Corporation but cannot buy shares in an S corporation.
What is an S Corporation?
An S corporation is just like a C corporation but with minor differences. Members of S corporation are also called shareholders who elect a board of directors to make business decisions.
A corporation must hold annual meetings to discuss important matters. It is also required to file annual reports, issue stocks, take minutes of meetings, and pay annual fees.
There’s no corporate income tax on S-corps. Between C Corporation and S Corporation, which is better for you?
The best choice will depend on several factors such as taxation, intentions to raise money from investors, some of your members are foreigners, don’t want a restriction on the number of shareholders, are a domestic corporation, just to name a few.
S Corporation vs. C Corporation: The Similarities
- Both are separate legal entities. This means that corporations are separate from their owners. The personal assets of the owners are therefore protected from creditors.
- Both provide limited liability for the owners
- Both need to file articles of incorporation
- They have a perpetual existence meaning a corporation will continue to exist unless it is dissolved, not when members die
- C and S Corporation can raise capital by selling their stocks. Investors can be lured to bring more capital avoiding unnecessary loans with high-interest rates.
- Members of both C Corporation and S Corporation are called Shareholders. They do not directly manage the corporation.
- In both corporations, shareholders must elect a board of directors who make business decisions
- All are required by law to file annual reports, hold annual meetings, issue stocks, take minutes of meetings, and pay annual fees.
S Corporation vs. C Corporation: The Differences
Number of members
Members are limited to 100
Have an unlimited number of members
Shareholders must be USA citizens and residents
Members can be foreigners or business entities
It is hard to attract investors because of shareholders and transfer restrictions.
Venture capitalists prefer to invest in C corporations because there are no shareholders and transfer restrictions.
There’s no corporate income tax on S-corps
It pays double taxation. Corporate income tax and its members pay personal income tax
Restrictions on classes of stock
Have restriction on classes of stock
Have different classes of stock
C Corporation vs. S Corporation: Formation
C Corp Formation
There are a number of crucial steps that you need to take in order to form a C corporation. Your state may not need some of these steps. Here are the major steps you need to take:
Name your business
Choose an available business name. Submit the name to your secretary of state. The name should end with the incorporated, corporation, or limited. This can be abbreviated as Inc., Corp, or Ltd.
State of formation
The second step is deciding where you are going to incorporate it. I would recommend setting up your corporation in your home state or where you plan to conduct business.
File official documents
Official documents needed to form either C corporation or S Corporation include articles of corporation and corporate bylaws. Articles of the corporation is a document that provides important information about a corporation.
It contains the name of a corporation, shares of stock, the purpose of the corporation, registered agent, contact information, just to name a few. Corporate bylaws are a set of rules that specify the management of a corporation.
You require directors for your corporation. If you have a small business, you can select yourself as the only director. Directors make decisions in the business. They are responsible for approving loans, issuing stocks, appointing officers, and many more.
Some states require a corporation to have 1 director while others it can be more depending on the number of owners.
Write Corporate Bylaws
Corporate bylaws are needed and they contain important info such as voting procedures, information about the corporation, financial audits, number of directors, annual meeting procedures, etc.
The next step is holding the first board of directors meeting, then issue stock, and finally, apply for a business license.
S Corp Formation
Setting up an S Corp is easy. To have one, apply to the IRS and make sure your business is structured as a C corporation (for guides to all company forms see this post).
Other requirements of forming an S Corp include not having more than 100 shareholders, having only 1 class of stock, shareholders must be USA citizens and residents and it needs to be a domestic corporation.
C Corporation vs. S Corporation: Ownership
Shareholders are basically the owners of a C or S Corp. C Corp can be formed by an unlimited number of members while S Corp is not allowed to have more than 100.
Members can be foreigners or business entities for C Corp. This is not the case with S Corp. Only United States citizens can form an S Corp.
Wondering what is the key difference between C Corp and an S Corp? It is their taxation. C Corp is subject to double taxation while there is no corporate tax on S corporation.
That is why some entrepreneurs choose S corporation in order to save on taxes (see 'How To Become An Entrepreneur' post, as well).
C Corporation Taxation
A-C corporation pays corporate tax. This is a percentage of a corporation’s profit which is calculated by deducting various expenses and salaries from its income.
On top of that, shareholders are required to pay personal income tax. This is money received as dividends from the corporation. This is what is called double taxation.
A corporation can avoid this by converting to S corporation which pays only 1 tax; personal income tax.
S Corporation Taxation
An S Corporation is just like a sole proprietorship business where taxes are paid by the shareholder(s). This business pays only personal income tax. Let’s say you are the only shareholder of your S Corp and it made $100,000 profits. No corporation tax to pay, only personal tax.
Corporate Ownership Compared
Just like I mentioned before, C Corps don’t have restrictions when it comes to ownership. Shareholders are the owners of a corporation. Although they are the owners, they cannot make major decisions about the corporation.
They need to elect a board of directors who will run the business. A-C Corporation does not have limitations when it comes to the type or number of shareholders. The business can have an unlimited number of members.
Anyone can be a member, even a foreigner or business entities. This makes C corporative attractive to outside investment.
This is the opposite of an S corporation. Members cannot be more than 100. They cannot be business entities or foreigners; they must be the United States of America citizens. In order to form an S Corp, incorporate first, then send the application to IRS. You need to file the 2553 form.
S Corporation Advantages
As a business owner, you should be aware of the advantages and disadvantages of an S Corp before converting it into one.
These will help you align with your business goals.
A corporation must submit a Form 2553 with the IRS (internet revenue services) plus meet the requirements of becoming an S corporation such as not having more than 100 members, be a domestic corporation and owners must be United States citizens in order to enjoy all the benefits of an S corp.
You may be wondering what the pros of an S corporation are. The main one is taxation. This is a business that has decided to be taxed as a flow-through entity. This means that tax is not paid at the corporate level but only at the individual level.
Other advantages include limited liability protection for owners.
S-corps avoid double taxation
Unlike C Corporation, S Corps do not pay corporate tax. Instead, they pay only personal income tax.
You can avoid the double taxation that is always associated with C Corps. This is a lot of cash that you can save to invest in other areas of your business. This makes S corporation an attractive business choice.
Limited Liability protection for owners
One major advantage of an S Corp is limited liability protection for owners. This means that the assets of owners are protected from the creditors in case a corporation fails to pay its loans.
S Corporation Disadvantages
Despite these advantages, S corps have strict qualification requirements.
- First of all, it cannot have more than 100 shareholders.
- Members cannot be foreigners or business entities. They must be USA citizens.
- Must be a domestic corporation
- Have only 1 class of stock
Restrictions of ownership
If you want to have international shareholders, you cannot have an S Corp. This type of corporation does not enjoy the flexibility in their ownership structure. Members cannot be foreigners, and cannot be more than 100.
Shareholders can also not come from other corporates or certain trusts. Also, S Corp is allowed to issue only 1 class of stock making it unattractive to investors.
Long Process of Formation
If you want to form an S corporation, you must begin as a C corporation. The next step is filing form 2553 then submit it to IRS. Make sure you have met all the requirements of forming one.
Not suitable for a Growing business
Generally speaking, An S Corp is not suitable for a growing business that wants constant funding. Its restrictions of ownership and having only 1 class of stock makes it not attractive for investors.
Not suitable for a foreign corporation
One of the requirements of converting to an S Corp is by having a domestic corporation. If you are a foreign corporation, you cannot file for S-Corp status.
C Corporation Advantages
When a business incorporates, it automatically becomes a C corporation. This is an individual entity that is separate from its shareholders. It is responsible for paying its own debts hence personal assets of shareholders cannot be used to pay them.
It is extremely important for you to know all the advantages of a C Corp so as to help you decide if it’s the right choice for you or not.
There are numerous advantages associated with forming a C Corp and they include:
- Limited liability protection for owners
- Able to raise capital
- Have an unlimited number of members
- Members can be foreigners or business entities
- Have different classes of stock
- Continue to exist even if an owner dies
Limited Liability Protection for owners
Many people choose this form of business because of limited liability. This business is an individual entity hence shareholders, directors, employees, officers are not held responsible for its losses or liabilities.
They cannot be sued and creditors cannot go after their personal assets.
Easy access to investments
C Corporation does not have restrictions of ownership plus has different classes of stock making it attractive to investors. There are stocks to sell hence it is easy to raise capital.
Members can be foreigners
C Corp does not have membership restrictions. You can have international members, even investors buy shares in your corporation. You can also have an unlimited number of members in your corporation.
C Corporation Disadvantages
Although there are numerous benefits of running a C Corporation, there are disadvantages just like any other business.
It’s crucial to understand the disadvantages of a C Corp. To some, the disadvantages may outweigh the advantages.
Some of the cons are:
The first drawback of a corporation is double taxation (at the individual and corporate level) on all the company’s gains. The dual taxation makes C Corporations unattractive to people who want to invest in them.
However, such firms can avoid dual taxation by converting to S corporation or by not giving out benefits to their shareholders and, rather reinvest their gains in the firm for continued growth.
Establishment, Maintenance, and Compliance Requirements
When compared to other corporations, C Corporations have to meet many regulatory requirements. The company’s structure isn’t very flexible. There are also strict company standards that must be followed.
Some of the strict requirements are from the management and owners. The management must remain accountable to the shareholders who appointed them and at the same time be beneficial to the corporation.
Therefore, there’s a need for shareholders and the Board of Director’s meetings to discuss some of these things.
How to Become a C Corp (C Corporation)
All corporations begin automatically as C Corps and have to adhere to certain rules. They can lose their status if they don’t follow the rules. If you want to form a C Corp, follow these steps:
Name Your Corporation
Choose a legit name. It shouldn’t be another company’s name in your state. To register your name, present it to your state’s secretary. You may need to submit 1-3 business name choices.
Elect a board of directors
Choose your business’s directors and officers. The directors supervise business operations and make decisions for the firm. They choose officers, who are responsible for day-to-day activities.
File articles of Incorporation
These are formal documents that make your business a legitimate corporation. The articles of Incorporation includes the name, directors, and address for your business.
Issue Stock Certificates
All C Corporations have shares. Shares symbolize the company’s ownership. Give share certificates to shareholders. Share certificates split the firm into percentages between other shareholders and you.
Apply for Licenses and Business Identification Numbers
Get a license from your state trade agency. Check what the requirements for the permits and licenses are that you will apply.
How to Become an S Corp (S Corporation)
If you’re planning to begin a business, the old saying goes: Start small and think big. An S Corporation offers the business the opportunity to grow by being tax-friendly and offering limited liability protection for its owners.
If you want to start an S Corporation (for buying already established business see here), follow these 6 steps:
Select a legit name. Perform a local search to make sure it is unique then register it.
Shareholders need to elect a board of directors that will be responsible for making major decisions about your Corporation.
File important documents such as articles of incorporation and corporate bylaws with your state secretary.
Articles of incorporation and corporate by-laws have a lot of information about the corporation such as an address, type of stock issued, have duties of directors and shareholders.
Apply for a trade permit and other business credentials particular to your business
Within 75 days of the formation of your corporation, you should file the IRS form 2553. Before filing this document, make sure you meet the requirements of forming an S corporation.
- Have only 1 class of stock
- Members cannot be more than 100 shareholders.
- Must be a domestic corporation
- Members cannot be foreigners or business entities. They must be USA citizens.
What If You Want to Change How Your Corporation is taxed?
It is possible to change your mind later about how your corporation should be taxed. Maybe your goals changed, want members to be foreigners, tax laws are different, or issue different classes of stocks.
It is possible to change from S Corporation to C Corporation and vice versa. Tax laws are not simple and it is crucial to consult with experts who will advise on how your business should be taxed. You can also take advantage of tax cuts that have reduced corporation tax by 20%.
Selecting Between C Corp and S Corp: Which is Best for Your Small Business?
Each business that applies for the corporation is at first categorized as a C Corp.
After incorporating, you’ll need to apply for the S Corp subchapter rank. Make sure you have qualified to form an S Corp.
- Not more than 100 shareholders (all individuals)
- You should have 1 class of stock
- Should be owned by US citizens but not foreigners
All these are fairly simple necessities for forming an S corporation.
Avoid Double Taxation by Choosing S Corp
An S Corp isn’t subjected to dual taxation like C Corp. This implies that an S Corp’s income isn’t taxed at the corporate level. If you want to save money on tax, choose an S Corp. Also, it's worth noting that setting up a bank account should be one of your top priorities as explained in our post on the best banks for small companies.
An S Corp can save you hundreds or thousands of dollars. For that reason, an S Corp is fit for a small business that wants to save on tax and does not have significant startup costs.
However, if you prefer S Corp, ensure you have a worthy accountant as a single mistake can make your S Corp taxed as a C Corp, making it to be taxed twice.
Avoid restrictions by Choosing C Corp
Choose C Corp if you do not want restrictions when it comes to ownership and shares. C Corps can have foreign shareholders, have an unlimited number of members, issue different kinds of stocks making them attractive to investors.
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