Sunday, 25 October 2020

S Corp vs. C Corp: Which is Better for Your Business?

S Corp vs. C Corp: Which is Better for Your Business?
25 Jun
6:49

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When incorporating a business, you would have the option to choose an S corporation or C corporation structure. The entity you select determines how much you would owe in taxes and how shareholders would interact with your business.

Although other corporate structures are also available, like B corporation and nonprofit corporation, S corp and C corp are common options for business owners. A C corp is the standard, default corporation that separates owners from the company. An S corp is also an individual entity separate from the owners, but S corps must follow different tax and shareholder guidelines.

Keep reading to learn about S Corp vs. C corp and how to choose the right corporate entity for your business.

S corp vs. C corp: The differences

Both types of businesses must be incorporated in the same way. You would need to register the business with state agencies wherever you conduct business, as well as file your articles of incorporation with your state’s secretary of state office. Corporations are also required to have bylaws, which act as the governing documents for the business, and file annual reports.

Also, an S corp and a C corp both protect owners from personal liability. Any type of corporation acts as an individual entity with its own rights and liabilities. Corporations can enter into contracts, get sued and sue others just as business owners can.

From there, S corps and C corps have distinct differences. Next, we’ll discuss what sets one type of corporation apart from the other.

Taxation

S corp: An S corp is considered a pass-through entity, meaning all company profits and losses would be passed through to the owner’s personal income. The business owner would pay taxes based on their personal income tax rate. S corps are not subject to corporate income tax. To become an S corp, the business would need to submit IRS Form 2553 and include signatures from all shareholders.

Under new tax laws that went into effect in 2018, owners of pass-through businesses can deduct up to 20% of their qualified business income. However, service- or trade-based businesses may be excluded from being eligible for the deduction. Companies that produce tangible goods, such as manufacturing companies, are more likely to qualify.

C corp: Unlike S corps, C corps must pay corporate income tax on profits. C corps are often subject to double taxation – the corporation itself is taxed and shareholders must pay taxes on dividends on their personal tax returns.

The recent tax reform also brought changes for C corps. As of 2018, the top corporate tax rate is capped at 21%.

C corps and S corps may also be responsible for employment taxes and excise taxes, depending on the nature of the business.

Shareholder criteria

S corp: An S corp cannot exceed 100 shareholders, and all shareholders must be U.S. citizens. Other corporations or partnerships cannot act as shareholders in an S corp.

S corps can only issue common stock, and the limit on the number of shareholders could prevent the company from raising significant capital from shareholders. However, S corp shareholders are typically highly involved in the business and prefer to have a say in operations.

C corp: Unlike S corps, C corps are not limited in the number of shareholders who hold stock in the company. C corps have more flexibility to sell different types of stock, which would allow the company to raise capital through shareholders when needed.

C corp shareholders may not be as invested in the business as S corp shareholders. C corps often have a large number of shareholders who may have little interest in the day-to-day happenings of the business. Depending on the type of stock issued, some shareholders may have voting rights while others may not.

Public ownership

S corp: Because of the legal cap on the number of shareholders, S corps cannot become public companies. If the company wants to go public, it would have to convert to a C corp structure.

C corp: A C corp’s ability to have an unlimited number of stockholders makes it possible for the corporation to go public and raise investment capital.

Comparing S corps and C corps at a glance

Here’s a quick look at the main differences between an S corp and a C corp.

  S corporation C corporation
Taxation Pass-through entity – Profits and losses are “passed through” to an owner’s personal taxes . Owners may deduct up to 20% of eligible income. Double taxation – Corporations must pay tax on profits and shareholders must pay tax on dividends. Corporate tax rate is capped at 21%
Ownership Limited shareholders – Restricted to 100 shareholders who must be U.S. citizens. Unlimited shareholders – No cap on the number of shareholders. Shareholders do not have to be U.S. citizens or residents. Corporation may go public.
Shareholder rights Common stock – All shareholders receive common stock, as well as disbursements of company profit. Voting power is tied to the amount of stock a shareholder possesses. Varying types of stock – Shareholders can receive different types of stock, which would affect voting power. Shareholders also receive dividends.

Which corporate entity is right for you?

For business owners looking for limited liability, a corporate structure could be a good entity choice. Whether you choose an S corp or C corp would depend on your aspirations for the corporation.

  • If you don’t want to pay corporate taxes:
    An S corp structure would allow you to avoid corporate taxes. Instead, profits and losses would pass through to your personal taxes, and you could be eligible to deduct up to 20% of eligible income. Be aware that some states tax S corp shareholders, in which case you would be subject to double taxation.
  • If you want to go public:
    C corps can become public companies, while S corps cannot. Also, a C corp would be the better choice if you plan to raise capital through the sale of stock to shareholders. C corps do not face a limit on shareholders, while S corps must cap the number of shareholders at 100.
  • If you want shareholder input:
    Although S corps cannot have as many shareholders as C corps, S corp shareholders are typically heavily involved in the business. Shareholders may be employees who feel invested in the company and want a say in daily activities and decisions.

It is possible to change your business structure. You could change your entity at a later time if you want to switch between an S corp and a C corp. However, your state could impose restrictions when it comes to changing corporate structures. Consider seeking out a local business adviser, attorney or accountant to help you choose the right corporate structure for your business.

The information in this article is accurate as of the date of publishing. 

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Melissa Wylie

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