S Corp vs C Corp: What You Need to Know

S Corporation

S Corporation, also sometimes referred to as an S Subchapter, is a business that operates with a special tax status in its interaction with the Internal Revenue Service (IRS) and enjoys certain tax benefits.

Corporate taxes that are filed under this Subchapter can be passed onto shareholders. In other words, they are referred to as pass-through taxation entities.

These corporations have the option of filing an informational federal return. However, tax is paid only once at the individual level and not at the corporate level.

The profits and losses of the business are “passed through” to the shareholders and are counted along with the shareholder’s personal tax returns. There are, however, certain restrictions on how many shareholders there can be in an S Corporation (not more than 100).

The IRS also requires the shareholders to be citizens or residents of the United States. S Corporations can also have only one class of stock.

C Corporation

C Corporation, also referred to as C Subchapter (after the Subchapter under which it is taxed), consists of separately taxable entities.

A C Corporation is the standard type of corporation that a new entity is assigned unless you file your tax returns using a different form (Form 2553).

C Corporations file corporate tax returns using Form 1120 and the taxes are paid at the corporate level. In addition to that, if the corporate income is distributed among shareholders and business owners in the form of dividends, then there is also a possibility of double taxation.

This is considered to be personal income that is taxed on an individual level. In other words, one of the biggest differences between an S corporation and C Corporation is that the latter is taxed twice, while the former enjoys certain tax benefits and is taxed only once.

However, unlike S Corporations, there is no limit to how many business owners and shareholders can participate in a C Corporation. A C Corporation can also have more than one class of stock, unlike an S Corporation.

Pros and Cons: S Corp vs C Corp

Both forms of corporations have their own share of pros and cons. The following is a brief list of the advantages and disadvantages that you may want to consider before registering your company:

S Corporation Advantages

• There is only single taxation in an S corporation as there are no taxes to be filed at the corporate level. The income can be distributed among shareholders and taxed at the individual level.
• While the profits of an S Corporation can be passed through to the shareholders, so can the losses. This softens the blow on bad financial quarters. The losses can also be declared in order to offset income.
• Eligible S Corporation shareholders can also get a deduction of up to 20% of the net qualified business income. This is made possible under the Tax Cuts and Job Acts of 2017.

S Corporation Disadvantages

• There is a restriction on the number of shareholders the corporation can have. Since the corporation cannot have more than 100 shareholders, it cannot go public.
• Apart from the number of shareholders, there is also a restriction on other aspects of ownership. The restrictions make it difficult for an S Corporation to acquire equity financing.
• An S Corporation can only have one class of stock, which disallows owners from asserting their preferences in stock.
• It is difficult for a shareholder to sell their stock and exit the corporation.

C Corporation Advantages

• There are no restrictions on the number of shareholders, allowing the corporation to go public and invite financing from private entities and venture capitalists.
• Anybody is allowed to own shares in a C Corporation, even non-US citizens.
• Unlike S Corporations, there is no restriction on the class of stock a C Corporation can have. Such a corporation can also have stock with preferences for distributions and dividends.
• According to the 2017 tax reform act, the corporate tax rate for C Corporations has been lowered to a flat 21%.
• You can get equity financing with greater ease as there are fewer restrictions on C Corporations, compared to S Corporations.

C Corporation Disadvantages

• The biggest drawback of a C Corporation is that it gets taxed twice—once on the corporation’s earnings and another on an individual level when shareholders are taxed on dividends.

Can One Make a Switch?

When your business is incorporated, you make a certain choice about how you want to be taxed. However, it is not as if you cannot change your mind later or alter the way your company functions.

After all, as you go along, your business goals may change as well. You may have started out as an S Corporation, but may want to garner easier equity financing later which may prompt you to switch. It is also possible that tax laws in your state changed such that your company would benefit more from being taxed differently.

Whatever your reasons are, if you are looking to change how your corporation is taxed, consult a tax advisor to learn more about making the switch

Final Thoughts

Deciding how you should incorporate your company will depend on several factors, including what your long-term business goal is, how you want to be taxed and what kind of formation the company will best benefit from.

If it is a small company with less than 100 shareholders, then an S Corporation may be the better option. Sit with a tax advisor and choose the direction that is best for your company.