When incorporating your business, it is necessary to make a decision regarding the type of corporation you want to be. Luckily, there are numerous options available to you, and two of the most popular are what as known as 'S' corporations and 'C' corporations.
But what are they? And what separates the two? While there is no real difference in the process of obtaining a certificate of incorporation for either of these corporate models, they still offer different benefits and drawbacks. Therefore, understanding the difference between an S-corp and a C-corp is still an important distinction that you have to make – and on which you should base your choice.
To help you out, this is what you need to know.
What Is a C-Corp?
The most common type of corporation is undoubtedly a C-corp and is named after subchapter C of the Internal Revenue Code (IRC). Essentially, the key distinguisher of this status is that the profits of a C-corp are taxed separately from its owners, under the provisions of the code.
It is implemented by following the standard process of incorporation, submitting the necessary documents (and fees), and then receiving the certificate of incorporation.
What Is an S-Corp?
An S-corp, meanwhile, follows subchapter S of the IRC, and entails profits being passed on to your company's shareholders (who are then taxed based on personal returns). When opting to adopt this approach, additional steps will need to be taken, such as stock issuance and the conducting of shareholder or director meetings. There may also be separate location-based requirements related to S-corporations that will have to be met for compliance purposes.
S-Corporation vs C-Corporation
Given these difference, then, what is the best option for your organisation?
As a small business owner, your primary concern when making this decision should ultimately be taxation. Irrespective of the type of corporation you choose, you will have to pay personal income tax on any salary you receive from the company as well as any dividends received.
As already mentioned, an S-corp is categorised as a pass-through tax entity whereas a C-corp will be taxed separately, which means that:
- S-corporations will not pay taxes at the corporate level and the onus to pay taxes rests on the individual owners. Here, the company files a return only for informational purposes and any profits or losses incurred in the business are to be reported on the personal tax returns submitted by the owners.
- C-corporations, meanwhile, have to pay taxes at the corporate level. Here, double taxation is a strong possibility when dividends are issued to the owners as this will have to be reported on their personal tax returns too.
As regards corporate ownership and stocks, it's also necessary to consider the following. An S-corp:
- Must be a domestic entity with no foreign owners.
- The number of shareholders can not exceed 100.
- Only one type of stock can be issued.
- S-corporations cannot be owned by other S-corporations (except in certain cases).
- They also cannot be owned by C-corporations, partnerships, LLCs or the majority of trusts.
In contrast, there are no restrictions on ownership of C-corps and these companies can offer multiple classes of stocks.
Choosing Between the Two
While there is no one single formula that can fit every company's requirements, there are some reasons why the scale might tip in favour of one or the other of these two categories.
Reasons to Consider an S-Corp
- You do not plan on launching an IPO and do not intend to have more than 100 shareholders at any time.
- Your company plans to distribute its income to the shareholders.
- You want to decrease the tax liability of your shareholders by utilising the pass-through entity (deductions of up to 20% of business income can be claimed on individual tax returns by owners).
- You want to avoid the risk of double taxation.
- You are a small company or a one-person organisation that is not hampered in any way by S-corp restrictions.
Reasons to Consider a C-Corp
- It is easier to form as it is the default type of corporation.
- It is possible to deduct the expense of fringe benefits given to employees such as health insurance or disability.
- You do not plan to distribute income to shareholders.
- You want to ensure the smooth transfer of shares.
- You plan on issuing preferred stock (which makes it easier to secure money for the business).
- You want to keep the option open of going in for an IPO or looking for investors.
- You plan on making charitable donations on behalf of your company (philanthropic contributions are 100% tax-deductible, as long as they do not exceed 10% of the company's total income). A C-corp is the only corporate structure that allows this.
- You have (or plan to have) foreign shareholders. This is particularly important if your organisation has - or seeks to have - a global reach.
Changing From a C-Corp to an S-Corp
In most jurisdictions, C-corporation status is assigned by default if no preference is indicated. However, this doesn't mean that you are tied into such a structure permanently.
It is entirely possible further down the line to convert your company from a C-corporation into an S-corporation – providing you satisfy all the conditions for doing so. For instance, you may have significantly modified your business goals, or you may be responding to major changes in tax legislation that could negatively (or positively) affect your company. All you have to do is inform your relevant registration body, and complete the necessary paperwork as required.
Figuring out the difference between an S-corp and a C-corp is useful, but it is essential to remember that every business is unique – as are its goals and requirements. The location that your company is operating from will also play an important role in determining the type of corporation you set up, as it will impact key company matters such as the type of financing you receive, the taxes you pay, and the growth of the organisation.
Therefore, making an informed decision will ensure that your business and its interests are safeguarded and enabled to achieve maximum potential. Consulting a qualified tax attorney about which is the best course of action is also a good idea, although the points listed above should give you a solid grounding of the key pros and cons.
What are your thoughts on the S-corp v C-corp debate? Let us know in the comment section below!