S-Corp vs. C-Corp
The differences between an S-corp vs. C-corp are how they’re formed, how they’re taxed, and their ownership restrictions. A C-corp is the default type of corporation, is subject to the corporate tax rate, and has no restrictions on ownership—whereas, with an S-corp, you must file specifically for formation, taxes are pass-through and reported on the owner’s personal taxes, and ownership is restricted to up to 100 shareholders.
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. a 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.
In this guide, therefore, we’ll explain the differences between an S-corp vs. a C-Corp, the pros and cons of each of these entity types, and how you can decide which is right for your business.
S-Corp vs. C-Corp, Summarized
| S-Corp | C-Corp | |
|---|---|---|
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Formation:
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Elect by filing IRS Form 2553
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Default type of corporation
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Taxes:
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Personal income tax on profits (pass-through taxation)
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Corporate tax plus personal income tax on dividends
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Raising Capital:
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Harder to raise venture capital
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Better for raising venture capital
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Number of Shareholders and Stock Classes:
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100 or fewer shareholders, one class of stock
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Unlimited shareholders, multiple classes of stock
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Type of Shareholders:
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Shareholders must be U.S. citizens or residents
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U.S.-based and foreign shareholders okay
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What Are the Differences Between an S-Corp vs. C-Corp?
As you can see in the summary above, the differences between S-corporations and C-corporations can be broken down into three major categories: formation, taxation, and ownership.
Generally, taxes are considered the biggest and most important difference between these two types of corporations. C-corps are subject to the corporate tax rate, whereas S-corps allow for pass-through taxation—meaning business profits and losses are reported on the owners’ personal income tax returns.
This being said, let’s dig into the differences between S-corps vs. C corps a little more—since these are ultimately what will have the biggest impact on your business’s bottom line.
1. Formation
The most basic difference between S-corporations and C-corporations is formation.
C-Corp Formation
The C-corp is the default type of corporation. When you file articles of incorporation with your secretary of state to register your business as a corporation, your company will become a standard C-corp.
S-Corp Formation
To structure your company as an S-corp, on the other hand, you must file IRS Form 2553 (shown below). After filing the form, you will become an S-corp for federal tax purposes. You might have to file additional papers at the state level to be treated as S-corp for state taxes.
IRS Form 2553 is used to form an S-corp. Image source: IRS.gov
This being said, whether you choose to structure your company as an S-corp or C-corp, you’ll need to follow some of the same steps for corporate formation. You’ll need to file articles of incorporation, appoint a registered agent, and create corporate bylaws.
For more information, check out our step-by-step guide on how to incorporate.
2. Taxation
As we mentioned above, taxation is the biggie when comparing an S-corp vs. a C-corp. Many business owners choose to structure their companies as S-corps to save money on taxes.
C-Corp Taxation
To start, C-corps are 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.
The only way to avoid double taxation is if you don’t make any profits (i.e. operate at a loss) or if you reinvest profits back into the business instead of providing a dividend. Wages and salary, including the owner’s salary, are generally considered deductible expenses, so you won’t have to pay taxes on that. However, the IRS can “re-label” excessive salaries as a taxable dividend.[1]
This being said, the Tax Cuts and Jobs Act—which you might know as the Trump tax plan—has brought changes to both C-corp and S-corp taxation. C-corporations now pay a flat 21% business tax rate, regardless of income or company size.
The law provides for a large tax cut for C-corps, but you still can’t escape double taxation as a C-corp. The company will first be taxed at the 21% corporate tax rate, and dividends are then subject to taxes on the personal income tax return. However, as we mentioned, if your business is in a growth stage and you’re planning to reinvest most profits back into the business (instead of paying frequent dividends), C-corp taxes could work in your favor.
S-Corp Taxation
Paying taxes as an S-corp is a bit different.
An S-corp is a pass-through entity for tax purposes, which means that shareholders report their share of the business’ income and losses on their personal tax return. Owners only have to pay taxes once at their personal income tax rate—they aren’t subject to a corporate tax.
As a shareholder of an S-corp, your business’s income is taxed on your personal income when you file Form 1120S.
Additionally, owners of S-corporations and other pass-through entities (like LLCs, sole proprietorships, and partnerships) can deduct 20% of qualified business income from their personal tax returns. This deduction expires in 2025, unless Congress extends the law.
Therefore, let’s say your business earns $100,000. To take a very simple example, you could deduct 20% of that income and only pay taxes on the remaining $80,000. Which businesses are eligible for the deduction changes every year based on inflation.
Currently, businesses with less than $157,500 in annual income (for single filers) or $315,000 (for married joint filers) can take full advantage of the deduction. Above those thresholds, the deduction is limited by the amount of wages that you pay to your employees.
Businesses in specific service trades or professions, such as consulting, medicine, or law, face limits on the deduction at high income levels.[2]
This being said, if you’re deciding between an S-corp vs. C-corp, you’ll want to ensure that you, your lawyer and your accountant take into account these tax laws.
S-Corp vs. C-Corp Tax Example
With these tax differences in mind, let’s look at another example to better understand what business taxes look like for S-corps vs. C-corps.
Suppose your business, a C-corp, has a taxable income of $100,000 (calculate taxable income by subtracting deductible expenses from your business revenue).
A C-corp would first have to pay the 21% corporate income tax rate, bringing the tax bill to $21,000. That leaves $79,000 left over. If you take all of that money as a dividend, it will be subject to a dividend tax rate, normally 15%. Your dividend tax bill will then be $11,850, bringing the total tax bill to $32,850.
In contrast, assume you have an S-corp with a taxable income of $100,000. That entire amount will flow through to your personal income tax return. For the 2019 tax year, that would put you in the 24% tax bracket, and the tax bill would be $18,289.50.
In this example, an S-corp saves you more money in taxes, but this isn’t always the case.
There are certain types of tax deductions, such as charitable donations and fringe benefits, that are fully deductible only for a C-corporation.
This being said, the only way to know whether an S-corp vs. C-corp structure is better from a tax standpoint is to crunch the numbers for your business, based on your projected profits for this year and future years. Your accountant or business attorney will help you figure out the structure friendliest to your bottom line.
3. Ownership
The last 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-Corp Ownership
C-corporations have no restrictions on ownership. You can have an unlimited number of shareholders, as well as different classes of shareholders.
Venture capital firms and angel investors prefer to hold preferred stock in a corporation, which is only an option for C-corps. This makes it much more difficult to fundraise as an S-corp.
Additionally, if you plan to sell your business down the line or spin-off a subsidiary, a C-corp could be a better choice. An S-corp can’t be owned by a C-corp, other S-corps, LLCs, general partnerships, or most trusts. C-corporations, on the other hand, can be owned by other corporations, LLCs, or trusts.
S-Corp Ownership
S-corporations can have only up to one hundred shareholders. Shareholders of an S-corp must be United States citizens or resident aliens, whereas C-corps are open to foreign investors.
S-corporations are limited to one class of stock, meaning that there’s only one kind of shareholder. There’s no hierarchy or difference between shareholders of the business, which makes fundraising harder.
What Are the Similarities Between S-Corp vs. C-Corp?
Although S-corps and C-corps are different in these three ways, they’re also similar in a number of ways. As types of corporations, S-corps and c-corps are distinct from other entity types—such as sole proprietorship, general partnership, or LLC.
This being said, breaking down the similarities between an S-corp and a C-corp can help you better understand each of these entity types, as well as why you might choose to form a corporation instead of another business entity. Their similarities can be summarized as such:
- Limited liability protection: As corporations, both S-corps and C-corps are legally separate entities from the owners—meaning their shareholders have limited liability protection. Put simply, this means that shareholders are not personally liable for the business’s debts or obligations. This is a major selling point of a corporation.
- Incorporation: As we mentioned above, if you structure your company as an S-corp or C-corp, you’ll need to follow the necessary steps for corporate formation. You’ll need to complete the proper incorporation documents, file articles of incorporation, appoint a registered agent, and create corporate bylaws.
- Structure: Although the shareholders of an S-corporation or C-corporation own the business, they don’t make most of the decisions. Management and policy issues are left to the company’s shareholder-elected board of directors. And the normal, day-to-day work of running the business is on the officers of the corporation—like the CEO, COO, and CTO.
- Compliance: Unlike other entity types, corporations (both S-corps and C-corps) have to meet certain documentation and compliance obligations—such as issuing stock, paying fees, and holding shareholder and director meetings.
Example of articles of incorporation that would be required for an S-corp or C-corp. Image source: NYC.gov
How to Decide Between S-Corporation vs. C-Corporation
Now that you know the three major differences—as well as the similarities—between an S-corp vs. C-corp, how can you decide between the two business entities? Many small business owners opt for S-corp status to save money on taxes. But, if you’re planning to raise investor money in the future or have plans to grow into a very large company, a C-corp might be the better option.
A lot of the benefits and disadvantages of both entities lie in those three differences we just outlined. Here’s another look at the advantages and disadvantages of S-corporations vs. C-corporations.
Advantages of an S-Corp
To start, here are some of the benefits of choosing an S-corp as your business entity type:
- Pass-through taxation: The taxation structure of an S-corp is undoubtedly its biggest benefit. S-corps don’t have to pay taxes on the business’s income twice. Avoiding double taxation is a huge benefit for smaller businesses.
- Deduction of business income: Current law allows owners of most S-corps and other pass-through entities to deduct 20% of their business income on their personal tax return. This business tax deduction can significantly reduce your tax burden.
- Tax filing requirements: Owners of S-corps can write off their business’s losses on their individual tax returns. This is a benefit for newer corporations that are likely operating at a loss for the first few years. As the owner, you can write off the losses of the business on your personal income statements, offsetting your income from other sources.
With these in mind, let’s review some of the advantages of choosing a C-corp:
Advantages of a C-Corp
- Easier to form: The C-corp is the default type of corporation, so there’s no additional paperwork to fill out.
- Fringe benefits: C-corporations can deduct the cost of fringe benefits provided to employees—like disability and health insurance. Shareholders of a C-corporation don’t pay taxes on their fringe benefits, as long as 70% of the corporation receives those same fringe benefits.
- Charitable donations: C-corporations are the only type of business entity that can deduct 100% of charitable contributions. The donations can’t exceed 10% of the business’s total income.
- Easier to raise money: It’s easier to raise money for your business if it’s a C-corp, since C-corps can issue multiple classes of stock to an unlimited number of shareholders. Plus, investors face no liability for the corporation’s mistakes—making it much easier to put money toward the business. Another benefit to note is that other businesses can own C-corps outright, which might be a better fit for companies looking to be acquired.
- No shareholder limit: C-corps can have as many shareholders as they want. Also, C-corps can have foreign (non-resident alien) shareholders, making it an ideal business entity for any company that intends to deal overseas.
On the other hand, of course, each of these types of corporations has its share of disadvantages as well. Let’s start by looking at the drawbacks of an S-corp:
Disadvantages of an S-Corp
- Harder to form: As we’ve mentioned, you have to file Form 2553 with the IRS and possibly additional state paperwork to elect S-corp status. You also have to make sure you stay within any restrictions (e.g. such as the 100 shareholders limit) to maintain S-corp status and avoid penalties.
- Limited ownership: Unlike C-corps, S-corps have a set cap on the number of shareholders they can take on—up to 100 shareholders. Plus, shareholders have to be legal residents of the United States. This poses a problem for high-growth businesses or businesses looking to conduct business affairs internationally.
- Limited stock flexibility: S-corps also prevent you from issuing preferred stock and different classes of stock, which can make it harder to raise money from investors and incentivize early owners.
- Tax qualifications: In general, S-corps tend to have more IRS scrutiny. If you make a mistake (like going over 100 shares or missing a filing deadline), the IRS can terminate your S-corp status—and you’ll be taxed as a C-corp.
With these in mind, let’s break down some of the drawbacks of a C-corp:
Disadvantages of a C-Corp
- Double taxation: As we’ve discussed, C-corps might pay more in taxes due to double taxation. The company’s revenue will be taxed at the corporate level and then again at the personal level if it’s distributed as shareholder dividends.
- No personal write-offs: Another tax-related downside is that owners can’t write off the losses of the business in their personal income statements—offsetting income from other sources.
As you can see, at the end of the day, when you’re comparing an S-corp vs. C-corp, there are a variety of different factors to consider. When it comes down to it, therefore, the right option for you will likely depend on the specifics of your company.
To this point, if you’re unsure of what’s best for your business—and what the further implications of any entity type might entail—it might be useful to consult a business attorney or online legal service to help you make the right decision.
How to Set Up Your Business as an S-Corp or C-Corp
So, if you do run through the pros and cons of S-corp vs. C-corp structures and decide on one of the two, you then actually have to set up your business.
Ultimately, the steps vary a bit depending on what state your business operates in. In most cases, you’ll begin by choosing a name for your business and filing articles of incorporation. You’ll also have to draft corporate bylaws, hold your first board of directors meeting, and issue stock certificates to your shareholders.
LegalZoom makes it simple to form a corporation online. Image source: LegalZoom
This being said, online legal services such as LegalZoom and IncFile make it fast and easy to file incorporation documents if you’re doing things yourself. But ideally, you should hire a lawyer to help you set up your corporation.
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How to Elect S-Corporation Status
As we’ve mentioned, becoming an S-corp takes one more step after setting up a C-corp. New businesses should file Form 2553 with the IRS within 75 days of the company’s formation date. If you’re an existing business that has switched over to S-corp status, then you should file your form no later than March 21.[3]
Some states also require you to file additional paperwork to elect S-corp status.
Once you elect S-corp status, it’s certainly possible to go back to a C-corp. However, doing so can have important tax consequences, so make sure to consult your accountant or a tax attorney first.
The Bottom Line
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. S-corps allow many small businesses to save money on taxes, but C-corps give you more options to expand and raise money.
This being said, before finally settling on a S-corp or C-corp structure, you may also want to consider don’t forget to consider other types of business entities. In particular, LLCs are a very small business-friendly type of ownership structure. LLCs offer limited liability and less burdensome paperwork and regulatory requirements than corporations.
In any case, it’s important to remember, the way you structure your business is a big decision and has big implications for 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.
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