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If you choose to structure your business entity as a corporation, you’ll be faced with an important decision—whether to set up your business as an S-corp vs. C-corp. This choice has big implications for how much you’ll pay in taxes, your ability to raise money, and the ease with which you can expand your business.
And when you’re the small business owner—not a lawyer or accountant—it can be hard to understand the differences between S-corporations vs. C-corporations. Or, admittedly, even be moved to care about why you might need to understand it in the first place. After all, isn’t that why you hired someone to get in the weeds with those forms—so you didn’t have to do it?
But the reality is that it’s important you understand the differences between S-corps vs. C-corps, too.
Although you might not be looking at the granular things your accountant or lawyer will, small businesses owners do need to know certain things about how these two business entities compare. That way, you’ll have the tools to choose which type of corporation is right for you. Plus, we’ve included some info on the new Trump tax plan, which should help, too.
Before we can understand the differences between C-corps and S-corps, let’s look closely at how these two types of corporations work. Here’s what it means to structure your business as a C-corp vs. S-corp. This’ll be the first step in helping you decide between them.
In a C-corporation, individual shareholders who hold shares of the company own the business. That’s the most important part here. The shareholders of a corporation have limited liability protection. Put simply, this means that shareholders of corporations are usually not liable for business debts or liability.
A C-corporation is the default form of a corporation—you know, what you generally think of when you think of a big corporation. So, unless you take specific steps (aka the ones outlined below) to slap an S on your corporation, you have a C-corporation. A C-corp is more common than S-corporations in the US.
The shareholders of a C-corporation own the business but don’t make the decisions. Instead, management and policy issues are left to the company’s shareholder-elected board of directors. The normal, day-to-day work of running the business is on the officers of the C-corporations—like the CEOs, COOs, and CTOs.
If you want to structure your business as a C-corporation, you have to file articles of incorporation with your state government. And once you’re up and running, you have certain compliance and documentation obligations as a corporation—like issuing stock, paying fees, and holding shareholder and director meetings.
The owners of a corporation can elect to structure themselves as an S-corporation. The split of control among shareholders, the board of directors, and officers is the same in S-corps and C-corps, and shareholders in S-corps also enjoy limited liability. The big difference here, however, is that the owners of an S-corp can take advantage of pass-through taxation. That’s where the profits and losses of the corporation are reported on the owners’ personal tax returns.
An S-corporation also has the same documentation and compliance obligations. S-corps need to file their articles of incorporation, and also need to issue stock, pay certain fees, hold shareholder and director meetings, etc.
→Too Long; Didn’t Read (TL;DR): For an S-corp vs. C-corp, these business entities are really more similar than they are different. But there are differences (more in a bit). The most relevant thing for you to consider is that S-corps are taxed differently using pass-through taxation.
The differences between S-corps vs. C-corps come down to three major categories: ownership, shareholder rights, and taxation—with the biggest difference being that last one, taxation. While C corporations are subject to the corporate tax rate, S-corps allow for pass through taxation so that business losses and profits are taxed at the owner’s (or owners’) personal income tax rates.
Let’s dig into these tax differences between S-corps vs. C-corps a little more, since this is what will have the biggest impact on your business’ bottom line—and, subsequently, your take home profits.
Taxation is the biggie when comparing S-corps vs. C-corps. If you choose to be an S-corp, you’ll have a different way of being taxed. Let us explain.
C-corps may be subject to “double taxation.” First, the C-corp is taxed at the corporate level when the owners file a corporate income tax return (Form 1120). A C-corp can then be taxed again, on the owners’ personal income tax returns, if corporate income is distributed to the corporation’s shareholders as dividends.
Like we started to mention above, paying taxes as an S-corp is a bit different. Shareholders report their share of the business’ income and losses on their personal tax return. As an S-corp, the income and losses of the business are divided among the shareholders and are taxed only at the personal income tax level—they aren’t subject to the corporate tax. As a shareholder of a S-corp, your business’s income is taxed on your personal income when you file Form 1120S.
This is why an S-corp is subject to pass-through taxation. Each shareholder’s part of the business’ income and losses passes through to their personal tax returns and is taxed at their personal income tax rate. (Hence, pass-through.)
Under the Tax Cuts and Jobs Act—which you might know as the Trump tax plan—there’ll be changes on the way for both C-corp and S-corp taxation. Some of the rules in the new tax bill took effect January 1, 2018, but business owners won’t see the impact of the changes until they file their taxes in 2019 (for the business year 2018).
There are two main things that small businesses need to know about the new rules:
These two changes mean that, under the new law, many small business owners, however they’ve structured their businesses, will pay lower taxes. But how will the new law affect your choice between S corp vs. C corp?
It depends, says John Blake, CPA, and partner with New Jersey-based accounting firm Klatzkin & Company, LLP. He explains, “This will have to be analyzed on a case by case basis. In the tax reform, Congress built in the 20% deduction for pass-through entities such as S-corps to make up for the lower C-corp tax rates.”
The only way to know whether a S-corp vs. C-corp structure is better for you taxwise is to crunch the numbers for your business, based on your projected profits for this year and future years. Your accountant or business lawyer will help you figure out the structure friendliest to your bottom line.
→TL;DR: There are pretty big differences in taxation between S-corps vs. C-corps—especially with new regulations from the Trump tax plan. S-corps use pass-through taxation while C-corps don’t—but C-corps enjoy a bigger tax break.
Another major difference between S-corp vs. C-corp structures is the restrictions on corporate ownership. C-corporations provide a bit more flexibility if you’re looking to expand your business or sell it to another company.
C-corporations have no restrictions on ownership. That means that you can have an unlimited number of shareholders. S-corporations, on the other hand, can have only up to one hundred shareholders. Shareholders of an S-corp must be United States citizens or permanent residents (non-resident aliens aren’t included), whereas C-corps are open to foreign investors.
Further, an S-corp can’t be owned by a C-corp, other S-corps, LLCs, general partnerships, or most trusts. C-corporations can be owned by other corporations, LLCs, or trusts.
→TL;DR: C-corps have a bit more flexibility in issuing stock if that’s a consideration for you.
One final difference between S-corps vs. C-corps has to do with shareholder rights. Both S-corps and C-corps issue stock to shareholders to sell pieces of ownership in the business.
However, S-corporations are limited to one class of stock, meaning that there’s one kind of shareholder. So, there’s no hierarchy or difference between any one shareholder of the business. Shareholders of S-corporations all have equal voting rights.
It’s quite a bit different in C-corps, in that C-corps can have different strata of shareholders at the top. That basically means that C-corps can divide up their voting rights by issuing different classes of stock.
What that basically means is that the different classes of stock and voting rights in a C-corporation value some shareholders votes over others. Typically, a C-corporation’s early-on owners and founders have the most say when voting—and the most control over the business.
→TL;DR: C-corps have a bit more flexibility in creating different levels of shareholder rights if you care about that, too. There’s only one class of stock in an S-corp, whereas there are different strata in a C-corp.
Now that you know the three major differences between an S-corp vs. C-corp, how can you decide between the two business entities? A lot of the benefits and disadvantages of both entities lie in those three differences we just outlined, so you might already have a clear picture. But let’s run through why you should (or shouldn’t) choose one of these business entities.
Here’s what might you make lean toward a C-corp in the S-corp vs. C-corp question:
Bigger companies benefit from having unlimited growth potential under a C-corp but typically pay a little more in taxes, reducing their net income. They also spend a little more effort complying with more regulation. But this calculus could change with the new tax laws, however, as C-corporation owners will end up paying less in taxes.
And let’s do the same for an S-corp in the S-corp vs. C-corp question:
→TL;DR: If you’re starting a business that you plan on keeping fairly small, with fewer than 100 shareholders and totally in the US, you probably want to be an S-corp. But if you have big plans for growing your company, you might want the flexibility to take on investors, raise capital, issue different kinds of stock, and invite foreign investors into your business as a C corp.
You’ve run through the pros and cons of S-corp vs. C-corp structures and are all systems go on one of the two. Awesome. Now you actually have to set up your business.
Although nuances are different on a state-by-state basis, these directions will help.
Here’s how you take the next steps and formally structure your business as a C-corp:
Need more help? Online legal services such as LegalZoom, Rocket Lawyer, and IncFile make it faster and easier to file articles of incorporation. For a flat rate of $50 to $200, these companies will help you create customized articles your business and file the paperwork on your behalf. The turnaround is typically three days to two weeks. Not bad!
Good news: Since an S-corporation is just a tax election, it’s almost the exact same process as setting up a C-corp:
Voila! Becoming an S-corp just takes one more step.
If you’re currently a C-corp and you want to switch to become an S-corp, then you’ll need to get the board’s approval. Remember that remaining an S-corp depends on your ability to keep up with the appropriate tax documents that specify your business as an S-corp. If you mess up your filing requirements, you risk losing your S-corp status and becoming a C-corp (again).
And, a reminder: Take care in switching from a C-corp to an S-corp because there are often taxes that are assessed as a result of the switch that make the switch cost prohibitive. Make sure you really analyze, with the help of an accountant or business lawyer, which structure will save your business more money in the long run.
→TL;DR: Structuring as a C-corp starts with filing articles of incorporation in your state’s secretary of state office. You’ll then have to draft corporate bylaws and hold your first board meeting. Creating an S-corp is exactly the same, and just requires one extra step form to file. You can snag some online legal help to speed up the process.
Now that you know the differences between an S-corp vs. C-corp, plus their advantages and disadvantages, you’re well equipped to make a smart choice for your business.
Here are the main things to keep in mind:
Remember, the way you structure your business is a big decision and has big implications on your business’s future. If you don’t feel sure about choosing your business entity or correctly structuring your company, consider talking to a small business lawyer or accountant.