If you are a small business owner, you have most likely heard of S corporations (also known as S corps) and C corporations (also known as C corps). But do you know what the differences are between them? Understanding the differences between these two types of businesses can help you decide which one is right for your business. Let’s take a look at S corp vs C corp and examine their similarities and differences.
S Corp vs. C Corp – Similarities
The main similarity between an S corp and a C corp is that both are entities that are separate from their owners/shareholders. This means that, as long as they follow all regulations and laws, neither entity will be held liable for any debts or obligations of the business. Both entities also offer limited liability protection to their owners/shareholders, meaning they will not be held personally liable if the business should fail or be sued. The other similarity is that both entities must pay taxes on profits they make each year.
S Corp vs. C Corp – Differences
There are several key differences between an S corporation and a C corporation, starting with how they file taxes. An S corporation files its own tax return, but does not pay any taxes on income it makes; instead, profits are passed through to individual shareholders who then pay taxes on their personal income tax returns. A C corporation pays its own corporate income taxes on profits it makes each year at a corporate tax rate that is often higher than personal income tax rates. Additionally, while an S corporation can only have one class of stock—meaning all shareholders have equal ownership—a C corporation can issue different classes of stock with varying rights to dividends or voting rights. Finally, while there is no limit to the number of shareholders an S corporation can have, a C corporation is limited to 100 shareholders (unless it meets certain criteria).
For most businesses, their business journey starts with a C corporation. However, if desired, those C corporation businesses may quickly and easily transform into an S corp by filing IRS Form 2553 alongside specific forms from the relevant state. After doing so, you can start taking advantage of all that S corps have to offer.
Interestingly enough, a S corp gets it’s name from Subchapter S of Chapter 1 of the Internal Revenue Code.
Achieving S corp status for the current year necessitates filing Form 2553 on or before March 15th if you’re running a calendar-year corporation. On the other hand, those businesses operating with an alternative fiscal year have until fifteenth day of the third month to file and must provide valid business reasons for doing so.
The primary motivation for selecting an S corporation is to minimize tax payments. Consequently, the procedure of filing taxes differs significantly between a C corp and an S corp.
- Using a C Corporation to run your business can be taxing as profits incur taxes that are reported on the corporation’s tax return. Plus, any dividends paid out after-tax will face double taxation if shareholders report this income on their individual tax returns. To avoid being taxed twice, consider electing S corp status for your entity which would require filing Form 1120 instead of paying extra taxes.
- By filing taxes through an S Corporation, you can enjoy the benefits of a sole proprietorship or partnership with the added bonus of not having to file on your own personal tax return. Unlike other entities, all profits (or losses) are passed straight through to each shareholder and reported directly on their Form 1120-S.
Numerous states permit the owners of S corporations to pass profits and losses through, yet a select few are known for double taxing such businesses.
If you’re looking for increased flexibility in selling shares of stock, a C corporation maybe the right choice. S corporations have some serious stipulations. An S corp may not:
- Have over 100 shareholders
- Have multiple classes of stock
- Have non U.S. citizenship or non-resident shareholders and cannot accept foreign investors.
- May not be held by a C Corporation, another S Corporation, LLCs (Limited Liability Companies), partnerships or other trusts.
These restrictions do not apply to C corporations.
Deciding between an S corp vs a C corp depends on your specific needs as a small business owner; understanding the similarities and differences between these two types of businesses will help you decide which option works best for your company’s goals. While both offer limited liability protection for owners/shareholders, there are significant differences in how each entity pays taxes and what type of stock options they can offer shareholders. Knowing these details before making a decision ensures that you choose the best entity for your business’s success. Do you need additional help creating your entity, building your business’ credit, or accessing funding? Well, that’s exactly what Estrada Vega Capital does! Feel free to click here to speak to one of our highly trained business experts.