Looking to set up a business and limit your liability as an owner? If yes, you need to know the difference between an S-Corporation vs C-Corporation and the pros and cons of each.
In this guide, we will explore the key differences between S-Corporations and C-Corporations. From tax implications to ownership structures, we will cover everything you need to know to make an informed decision for your business.
Let’s get started.
How Does Your Business Structure Affect Your Business?
The way you structure your business affects many things including your ability to obtain funding, taxes, and the paperwork required. It also dictates whether or not you’ll be protected from business liabilities.
The right business structure will help you do just that. While your options range from Sole Proprietorship and Corporation to LLC, a Corporation is the most complex and regulated structure.
Both S-Corporation and C-Corporation allow businesses to limit legal liability for shareholders. Similarly, both require a qualified Registered Agent as well. But they have their differences too.
Let’s now take a detailed look at S-Corporation vs C-Corporation to identify the best one for you.
What is an S-Corporation?
An S-Corporation is a special type of business entity that is taxed differently from a regular C-Corporation. S-Corporations are not subject to corporate income tax, but instead, the income or losses “pass-through” to the shareholders and are reported on their individual tax returns. However, they can only have up to 100 shareholders.
What is a C- Corporation?
C-Corporations are pure Corporations and are taxed as entities, meaning that the company itself pays corporate taxes on its profits. Additionally, the shareholders pay taxes on their dividends too. This leads to double taxation.
Before getting to the differences between S-Corporation vs C-Corporation, let’s look at the advantages and disadvantages of each.
Advantages of S-Corporation
There are many advantages of forming an S-corporation, these include:
- Pass-through taxation: Unlike C-Corporations, S-Corporations are not subject to double taxation. This means that the Corporation’s income is only taxed once at the individual level. This can save a significant amount of money in taxes.
- Income deduction: S-Corporations are also eligible for qualified business income deduction that allows them to deduct up to 20% of their qualified business income.
- Increased income: S-Corporation owners can receive both dividend payments and salary from the Corporation as dividends do not come under the purview of self-employment tax.
Disadvantages of S-Corporation
There are a few disadvantages of starting an S-Corporation. One is that they can only have one class of stock.
They also can’t have more than 100 shareholders, so if your company grows beyond that, you’ll need to switch to a C-Corporation.
These Corporations also have to allocate profits or losses based on the number of shares or percentage of ownership only.
Advantages of C-Corporation
Here are the advantages of a C-Corporation:
- No limit on shareholders
- Easier to raise capital
- No ownership restrictions
- No restrictions on issuing classes of stock
Disadvantages of C-Corporation
There are a few key disadvantages of C-Corporations to be aware of:
- Double taxation: C-Corporations are subject to corporate income tax on their profits, and then shareholders are also taxed on any dividends they receive. This can lead to a significant tax burden.
- Increased paperwork and compliance requirements: C-Corporations must file annual reports and other paperwork with the state, and they are subject to more regulations than other business types.
- Can be expensive to set up: There are different fees associated with setting up a Corporation, including the fees for filing the Articles of Incorporation in addition to legal and other government fees.
S-Corporation vs. C-Corporation: Key differences
There are several key differences between S-Corporations and C-Corporations.
Perhaps the most significant difference is that C-Corporations can raise capital through the sale of stock, whereas S-corporations cannot.
When it comes to S-Corporations vs. C-Corporations, another key difference is that an S-Corporation does not pay corporate income tax on its profits. Instead, the profits are “passed through” to the shareholders and taxed at their individual income tax rates.
A C-Corporation’s profits are first taxed at the corporate level, and then again at the shareholder level when they are distributed as dividends.
A key difference between S-Corporations and C-Corporations is that the latter has no restrictions in terms of ownership. Any individual or business entity can be an owner and there can be unlimited shareholders. S-Corporations can only have U.S. citizens as shareholders and there can only be a maximum of 100 shareholders.
Steps to Form a Corporation
Here are the steps to form a Corporation:
- Choose a name: The name should be unique and not registered to other business entities.
- Appoint corporate officers: To run your corporation, you will need to appoint a registered agent and a board of directors.
- Incorporate your S-Corp business: The Articles of Incorporation must be filed with the secretary of state.
- Acquire licenses: Apply and obtain all applicable local, state, and federal business licenses.
- Obtain EIN and file tax forms: It’s necessary to get your Employer Identification Number to be able to hire employees and open bank accounts.
The Key Takeaway
The choice of whether to form an S-Corporation vs. C-Corporation is an important one that will have long-term implications for your business.
As you can see, there are several key differences between the two types of entities, from how they are taxed to the level of personal liability their owners face.
Carefully consider which option is best for your business before moving forward.