Deciding whether to be taxed as a C corp or an S corp is an important business decision that impacts your tax obligations, ability to raise capital, and the stock your company issues.
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Choosing C-corp vs S-corp status for your business is an important decision that affects how your business is taxed, who owns it, and how it issues stock. Understanding these differences is crucial to avoiding any unexpected taxes or other pitfalls that can cost your business time and money.
Tax law is complicated, and wading through technical information can feel overwhelming. This article provides an overview of the subject, highlighting the key differences between these business structures and the considerations you should make when deciding which tax status is best for your business.
- C corps are the default type of corporations and are subject to double taxation. They can have an unlimited number of shareholders, including foreign investors.
- S-corp status allows a corporation to be taxed as a pass-through entity. It also offers other potential tax benefits, although S corps are limited to 100 shareholders and strict shareholder eligibility criteria apply.
- The right solution for your business depends on various factors, including the size of your business, plans for going public, and tax-planning considerations.
- When choosing to remain a C corp or elect S-corp status, you must speak with tax and legal advisors. They can help you understand which option is the best fit for your specific situation.
- Whether you run a C or an S corp, try using Connecteam to manage your workforce effectively.
C Corporation vs S Corporation
Corporations are businesses that are separate legal entities from their owners (shareholders). Forming a corporation is done at the state level through a process called incorporation. To incorporate your business, you file articles of incorporation—formal documents with information about the business you’re starting.
C corporations, or C corps, are the standard type of corporation formed when you file articles of incorporation. The “C” refers to the part of the Internal Revenue Code (the tax laws governing US taxes) that sets out how C corps are taxed.
C corps can elect for special tax status under Subchapter S of the Internal Revenue Code. When they do, they become S corporations or S corps.
To qualify for S-corp status, a company must meet specific requirements, which we discuss below. Some businesses, such as insurance companies and financial institutions, can’t apply for S-corp status.
🧠 Did You Know?
Limited liability companies (LLCs), usually taxed like sole proprietorships or partnerships, can elect to be taxed as C or S corps.
C Corp vs S Corp: Similarities
C and S corps are corporations, so they share several similar features.
Corporations are legal entities that are separate from their owners. They can sue, be sued, and enter into contracts—for example, to hire employees.
This separation protects the owners (shareholders) from personal responsibility for the business’s debts and liabilities (other financial obligations). Instead, shareholders are liable for the amount of their investment only. Shareholders’ personal assets are otherwise shielded from creditors if the business fails or faces a lawsuit.
Both C and S corps provide business owners with limited liability.
🧠 Did You Know?
If your corporation hires employees, a tool like Connecteam can make managing your workforce a breeze. With operations, communications, and HR features, Connecteam is an ideal people management solution for business owners across all industries.
As a corporation separates the business entity from its owners, C and S corps can continue to exist if an owner dies or leaves the business.
Articles of incorporation
Starting a C or S corp involves the same initial process. To do so, you need to file articles of incorporation with the relevant state agency. These documents provide the company’s details, including contact information, corporate structure, and directors’ details.
💡 Pro Tip:
The Small Business Administration’s (SBA) website has a helpful tool to find the relevant agency in your state.
C and S corps are made up of:
- Shareholders, who own the company.
- Directors, who are elected by the shareholders and guide high-level decision-making within the company.
- Officers, including a chief executive officer (CEO), who are appointed by the directors and are responsible for overseeing the day-to-day running of the company
Several people, or even 1 person, can perform all 3 roles, as long as their duties under each are kept separate.
Corporations must comply with a range of administrative requirements. These include:
- Drafting and adopting bylaws. Bylaws are the internal rules of an organization. They address issues like procedures for conducting shareholder and director meetings and decision-making processes. Bylaws must be in writing and stored at the principal business location.
- Appointing a registered agent who can accept legal service on behalf of the company in its state of registration.
- Conducting annual shareholder and director meetings for transparency and accountability.
- Filing annual reports that provide up-to-date contact details for the company with the relevant agency in your business’s formation state and any other state where you do business.
- Paying annual fees, typically due when you file annual reports.
- Submitting corporate tax returns.
Corporations generally need to engage tax professionals and legal advisors to assist them with complying with these requirements, creating additional business expenses.
What Is the Difference Between an S Corp and C Corp?
The main difference between S corps and C corps is how they’re taxed.
C corps are subject to “double taxation”—their profits are taxed at 2 levels. They pay federal corporate income taxes. Shareholders also report any dividends (regular payments of the company’s profits to shareholders) they receive on their personal tax returns and pay taxes on these at their individual tax rates.
In comparison, S corps are “pass-through entities,” which means they’re exempt from paying federal taxes at a corporate level. Instead, the profits, losses, deductions, and credits of the business “pass through” to the shareholders, who report them on their tax returns and pay tax on them at their individual rates.
Both C and S corps must file annual tax returns with the IRS—Form 1120 and Form 1120S, respectively. But while C corps pay federal income tax, S corps don’t.
You should compare the corporate tax rate with shareholders’ personal tax rates when comparing C corps vs. S corps. The current corporate tax rate is 21%, while the highest personal tax rate is 37%. Business owners may be guided by the choice that offers the lower tax rate.
You should also check whether the state where your business is registered requires S corps to pay state corporate income tax.
S corps offer other potential tax savings at an individual level:
- S corp shareholders may be entitled to deduct up to 20% of their qualified business income.
- Some S corp shareholders may also be able to use business losses to offset other income on their tax returns, reducing their overall tax liability.
C corps also offer some possible tax benefits at the corporate level, including:
- C corps can deduct the cost of fringe benefits, including health and disability insurance premiums, from their taxable income, reducing their tax burden.
- Some charitable donations are considered business expenses that the company can deduct up to a certain amount.
Aside from different tax arrangements, the Internal Revenue Code also restricts the ownership structure of S corps.
Shareholders can be individuals, certain trusts, and estates only. They can’t be non-resident aliens (i.e., foreign investors), other corporations, or partnerships. Plus, S corps can have up to 100 shareholders only, preventing them from going public (becoming a publicly traded company).
S corps are private corporations. A private company is owned by a limited number of shareholders—often its founders—and its shares can’t be traded on the stock exchange. In comparison, a public company’s shares are traded on the stock exchange and anyone can buy them.
These limitations can pose challenges for S corps regarding finding equity financing (raising business capital by selling shares). Professional investment firms, private equity funds, and certain angel investors are generally not eligible to be S corp shareholders.
In comparison, C corps can have an unlimited number of shareholders, including other corporations and foreign investors. This feature makes C corps attractive options for businesses intending to go public and list on the stock exchange.
Classes of stock
S corps are restricted to 1 class of stock, whereas C corps can issue both common and preferred stock.
Common stock gives the shareholder voting rights, whereas preferred stock doesn’t. Voting rights allow shareholders to have a say in certain business decisions, such as appointing directors. Shareholders with preferred stock are paid before those with common stock.
C-Corp vs S-Corp Status: How To Choose the Right One for Your Business
When choosing the right tax status for your corporation, compare the pros and cons relevant to your business.
C Corp pros and cons
|Offers limited liabilityAllows flexible ownership arrangements, including unlimited shareholders and foreign investmentFacilitates simpler equity financingEnables easy transfer of sharesPermits issuing multiple classes of stock
|Faces double taxationPrevents shareholders from writing off business losses on their personal tax returnsRequires more time and cost for set up and compliance compared to other types of businesses
S Corp pros and cons
|Provides limited liabilityUses pass-through tax structure to avoid double taxationOffers other potential tax advantages for shareholders
|Limits the number of shareholders to 100 Restricts foreign ownership and types of shareholdersMakes obtaining equity financing more difficultAllows for issuing 1 class of stock onlyPlaces limits on deductible employee benefits
When considering an S corporation vs C corporation, the right choice depends on your business’s circumstances, priorities, and objectives. For example, smaller, family-owned businesses tend to prefer S-corp status, while larger ones are generally C corps.
Factors you might consider when making this decision include:
- Long-term company goals, including whether you intend the company to go public.
- Size of your business.
- Intended ownership structure.
- Tax implications for the business and its shareholders.
- Sources of capital and fundraising.
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Don’t have a business yet but want to? Read our guide on how to start a business.
How To Form a Corporation
These are the general steps to form a C corp.
- Choose and register a unique business name. Each state has its own rules around naming a business. These typically prevent you from using a name that’s identical or similar to another business or require you to include certain designations—like “Inc.”—to show the business is incorporated. Business names are typically registered with the Secretary of State’s office.
- Appoint a board of directors and company officers.
- File articles of incorporation. The specific requirements and filing fees for articles of incorporation vary between states.
- Prepare a set of bylaws for the corporation.
- Issue stock certificates to shareholders. These are physical documents that serve as proof of ownership in a company. Doing this assists with the recordkeeping of share distribution.
- Apply for relevant federal, state, and local licenses. The licenses your business requires depend on your industry. The SBA provides a licenses and permits guide for small businesses.
- Apply for an Employer Identification Number (EIN) from the IRS.
🧠 Did You Know?
An EIN is a unique number the IRS uses to identify your business for tax purposes. Learn how to apply for an EIN in our handy guide.
Forming an S corp involves an additional step. The business must file Form 2553 with the IRS and a consent form signed by each shareholder.
Businesses that elect S-corp status must file Form 2553 no later than 2 months and 15 days after the beginning of the tax year. If your business’s tax year follows the calendar year, the deadline is March 15.
The Bottom Line on S-Corp vs C-Corp Status
Choosing the best tax status for your business involves carefully considering a range of factors and your business’s unique circumstances. Speak to tax and legal professionals before making a decision. They can give you relevant advice and explain the consequences for your business and its shareholders.
Whether you choose a C corp or an S corp, you need a way to manage your employees effectively. Connecteam’s comprehensive employee management app is the ideal solution. From streamlined onboarding to seamless scheduling and time tracking, Connecteam provides a comprehensive approach to enhancing your workforce’s efficiency to grow your corporation.
Can you change from a C corp to an S corp and vice versa?
Businesses can change from C corps to S corps by filing Form 2553 with the IRS. S corps can also revert to C corps by sending a statement of revocation to the IRS service center where they file annual returns. Before changing tax arrangements for your business, speak with a tax professional.
Can a C corp be owned by 1 person?
A C corp can have a single shareholder/owner. Single shareholder C corps must follow the same formation process and corporate formalities as any other C corp, including conducting and recording annual shareholder meetings.
The information on this website about an S corp vs C corp in the United States is intended to be a summary for informational purposes only. However, laws and regulations regularly change and may vary depending on individual circumstances. While we have made every effort to ensure the information provided is up-to-date and reliable, we cannot guarantee its completeness, accuracy, or applicability to your specific situation. Therefore, we strongly recommend that readers seek guidance from their legal department or a qualified attorney to ensure compliance with applicable laws and regulations. Please note that we cannot be held liable for any actions taken or not taken based on the information presented on this website.