What is the Difference Between an S Corp and C Corp?
Planning to incorporate your business is a smart choice if you are seeking to protect your personal assets. But should you select an S corporation or a C corporation? It’s important to know the difference between S corp and C corp before you make your decision. Here’s what you need to know.
Similarities Between S Corp and C Corp
Both S corps and C corps are legal entities, separate from yourself and any other owners of the business. This protects your personal assets from liability for any lawsuits or judgments against the business. Forming an S corp or C corp can also limit your risk of an IRS audit compared to operating as a sole proprietor or self-employed person.
As separate entities, both an S corp and a C corp can continue to “live on” after the business owner leaves the company or dies (this is known as “perpetual existence”). If you plan to form a family business and hope your children will carry it on, you may want to incorporate.
Both S corp and C corp are subject to state regulations, which include holding annual meetings, maintaining records of those meetings, filing annual reports and paying franchise taxes. This can become complex and time-consuming, but if you don’t comply with the regulations you could face fines and penalties.
Difference Between S Corp and C Corp
Most corporations are C corporations. C corps are owned by shareholders, who elect directors of the corporation. There is no limit on the number of shareholders a C corporation can have, and its shareholders can be from anywhere in the world, which makes this a good form of business if you have big plans to sell shares, raise equity capital and go global.
One big difference between S corp and C corp is that the C corporation faces what’s known as “double taxation.” The C corp pays both federal and state taxes on its profits at the corporate tax rate. If any earnings are distributed to the shareholders in the form of dividends, the shareholders have to pay taxes on the dividends at their individual tax rate.
The S corporation structure eliminates the “double taxation” trap of the C corporation. The S corporation itself doesn’t pay federal income tax. Instead, the company’s income (as well as any losses) pass through to its shareholders. The individual shareholders report income and losses on their personal tax returns, so the money is only taxed once.
Like a C corp, an S corp can also be used to raise equity capital, although there are some areas of difference between S corp and C corp here as well. You can only own an S corp if you are either a U.S. citizen or a naturalized, resident alien. An S corp can have a maximum of 100 shareholders, all of whom must be U.S. citizens, and it can only issue one class of stock. These restrictions provide less flexibility than the C corp when it comes to issuing shares, which could ultimately limit your growth.
In addition, an S corp cannot be owned by another business—only by individuals—while a C corp can. If you are forming a business that will be owned by another business, it needs to be a C corp.
To register as an S corp, you first incorporate as a C corp in your state and then file IRS Form 2553 to select federal tax status as an S corp.
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