Explain the difference between an s corporation and a c corporation.

Curious about the differences between a C corp and S corp? Learn more about key differences and benefits with this article.

If you are thinking about whether or not it's better to form a C corp or an S corp for your business, you’re in the right place. While a C corp may be best if you plan to go public one day, an S corp can be better for small companies. Each type of corporation has its own benefits and drawbacks, as well as differences when it comes to taxes.

This article takes a look at the differences between an S corp and C corp so that you can decide which is best for your business. Read on to learn more about C corporations vs S corporations.

Corporation Definition

A corporation is a legal entity that is considered distinct and separate from its owners. The law states that a corporation has many of the same rights as a person. corporations are able to loan and borrow money, sue and be sued, enter contracts, own assets, hire employees and pay taxes.

Additionally, a very important element of a corporation is its limited liability. That means that the company shareholders are not directly personally responsible for any of the business's debts, and that is a very positive aspect of a corporation for business owners.

What Is a C Corp?

A C corp is one type of corporate structure. A business may become a C corp for tax or legal and regulatory purposes, as C corps provide a number of tax benefits. As far as leadership structure, a C corp has an elected board of directors that can be determined by the company’s shareholders.

What Is an S Corp?

An S corp is another type of corporate structure. It is a variation of a corporation within subchapter S of Chapter 1 of the IRS code. This legal entity passes deductions, losses, income, and credit through shareholders for federal tax purposes, and has relief from double taxation and limited liability. While an S corp provides certain protections that a C corp doesn’t, it also comes with more restrictions.

What Is the Difference Between an S Corp and C Corp?

The primary difference between an S corp and a C corp is the manner in which they are taxed by the IRS. A C corp has its profits and losses stay in the business and files its own tax returns. A C corp also pays a 21% flat tax on profit. It does not pay any tax on earnings.

With an S corp, the profits and losses flow through to the shareholder. Shareholders can claim it on their personal tax return. Keep in mind that an LLC can be taxed as an S corp or be taxed as a C corp.

The other differences between an S corp and a C corp include formation and ownership. A C corp is looked at as a default type of corporation. Articles of incorporation must be filed in your particular state. An S corp needs to fill out this documentation in addition to filing Form 2553.

When it comes to actual ownership, C corps have minimal restrictions and virtually anyone can be an owner of the corporation, and there is no cap on the number of owners permitted. S corps, on the other hand, do have a limit on ownership. They are limited to 100 shareholders.

Below, we go into more detail about the key differences between S corps and C corps.

Formation

In order to form a C corp, you have to first form a corporation. The formation must be in alignment with your state laws. The process entails picking a corporate name, creating articles of incorporation, registering it with the secretary of state, preparing corporate bylaws, selecting directors, and holding the first board of directors meeting.

When you form a C corp, the first thing you have to do is to select a name for your corporation that no one else has in your state. Typically, you can select three names, then the business office will let you know which one they select.

The name of your corporation should end with limited, incorporated, or corporation. You also need to make sure that no other company has that trademark name. Just do a US patent and trademark search to find this information. Then you'll know if another company is using that trademark name.

Next, the directors need to be appointed. If you choose to appoint other offices, this should be done before filing. In order to make your new entity official, you will need to file articles of incorporation with the secretary of state's office. In order to file these papers, you may have to pay a filing fee that ranges from $40 to $450.

Every C corp must have bylaws. These are the guidelines and rules for the operation of your company. The bylaws should also include who can vote and when you will have directors' meetings. Failing to hold these meetings can result in a loss of your C corp status. Thus, these meetings should not be taken lightly. You may be asked by an authority to show the minutes.

You will also need to hold a first directors' meeting. At this meeting, the bylaws will be approved. The minutes of that meeting must be written down and kept on file. Regular meetings are one of the requirements for maintaining a your C corp status.

A C corp is the basic corporate structure. You can transition from a C corp to an S corp by filing a special form with the IRS. The IRS Form 2553 is used to accomplish this. It must be properly filled out, filed, and signed by all of the shareholders.

Formation costs

Based on market data, the average formation cost for an S corp is about $1,200. And the market data for the average formation cost for a C corp indicates that it is about $633. When you think about it, the cost for both is pretty reasonable, especially considering that you have the opportunity to start your own business. However, it’s clear that S corps incur greater formation costs than C corps.

Taxes

S corps don't actually pay corporate income taxes. The company’s individual shareholders split up the income and report it on their own personal income tax. This way, S corps avoid double taxation. S corps actually avoid the business tax by passing their income onto the business owners directly.

C corps are taxed differently. A C corp pays corporate income tax on its income. Its income is determined after deducting losses, credits, and deductions. The C corp then pays its shareholders dividends. The shareholders have to pay personal income taxes on these dividends. It is often referred to as double taxation and that can be one of the negative aspects of maintaining a C corp.

This is the main difference between S corp and C corp, and is often the factor that helps individuals decide between forming an S corporation vs C corporation.

Membership

Both US residents and US citizens can be shareholders of an S corp. An S corp is permitted to have a maximum of 100 shareholders. Even teenagers who are 18 years of age can become a shareholder in an S corp, but many other entities, like partnerships and trusts, are prohibited from holding stock in an S corp. This is important to know.

You do not have to be a US citizen or a US resident to be a shareholder in a C corp. This makes the membership requirements for a C corp much more flexible than the requirements set forth by an S corp.

Class of stock

Stock is always an important component of a publicly traded business. An S corp is only permitted to have one class of stock. In this respect, it is treated as having one class of stock when all shares of stock have the same rights of liquidation and distribution proceeds.

On the other hand, a C corp is allowed to have two or more classes of common stock. Additionally, the majority of voting rights are retained.

Shareholder origins

Another significant difference between C corps vs S corps has to do with the origin of the company’s shareholders. S corps must be domestically based and the owners of the company must be U.S. citizens of permanent residents. In contrast, C corps can be based out of anywhere and the owners don’t necessarily have to be U.S. citizens or residents.

C Corp vs S Corp: Which Is Best?

When it comes to tax treatment and business structure, it's really hard to say which one is better. The choice to decide whether to have an S corp or a C corp should really be based on the specific situation of the owner and the business.

Keep in mind that it is always wise to consult with tax professionals and legal professionals during any business formation process. These professionals will give you a basic understanding of the options that are available to you. It is also important to remember that many businesses have evolved from one structure into the other as they experienced growth. So, keep in mind that you have the option to change the structure of your business.

Final Notes

The S corp and the C corp are both legal entities for businesses. They have some similarities and they have differences, too. Before you choose which one to have for your business, it is important to collaborate with tax professionals and legal professionals. It is also wise to consider your own personal situation. You need to consider your income, your tax bracket and your lifestyle.

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