C corp vs S corp
When deciding how to incorporate a company, you can choose either the C corp or S corp route. The two have certain characteristics, yet there are also significant distinctions.
Make sure you weigh the benefits and drawbacks of your options thoroughly before settling on one.
Corporation Basics
Both C corp and S corporations have numerous commonalities. Shareholders are the legal owners of a company and have the right to elect the company’s leadership. The officers are hired by the board of directors to run the day-to-day business. Dividends are payments made from a company’s profits to its shareholders.
Stock must be issued, bylaws must be drafted and approved, annual meetings of directors and shareholders must be held, minutes must be kept, corporate resolutions must be issued for major decisions, and yearly reports must be filed with the state government along with annual fees. If these requirements aren’t met, the business and its owners may be exposed to personal responsibility.
When a business is organized as a corporation, the owners are shielded from personal responsibility for debts and other obligations. A corporation is an entity distinct from its shareholders when it is formed in accordance with state law. Since a corporation is a distinct legal entity, only corporate assets may be sued to satisfy corporate debts. Except in certain circumstances, shareholders are not personally responsible for business debts, and their personal assets are shielded from business creditors.
Under Internal Revenue Service regulations, the C corporation is the typical or default form of corporation. In order to take advantage of certain tax breaks offered by the Internal Revenue Service, some corporations choose to elect a special tax status, such as the S company.
The sections of the IRS tax code under which each type of company entity operates provided the inspiration for their names. Subchapter C deals with the taxation of C companies, whereas Subchapter S deals with the taxation of S corporations. If you want your newly formed company to be treated as an S corporation, you must submit IRS Form 2553 and adhere to all of the S corporation rules and regulations.
Even though C companies and S corporations have certain similarities, there are still important distinctions between the two.
Formation
In the United States, all businesses must register as C companies. By submitting Form 2553 with the IRS, Election by a Small Business Corporation, a C corporation can change its tax status to that of a S corporation (IRS). For state tax purposes, forming a S corporation may require the filing of additional paperwork with the state.
If your company follows a calendar year for accounting purposes, you must file Form 2553 by March 15 to be considered an S corporation for that year. For companies that operate on a different fiscal year, the deadline for submission is the 15th day of the third month of that year. It’s also acceptable at any time throughout the preceding tax year.
Taxation
Choosing an S company is typically done so as to reduce overall taxable income. When it comes to taxation, a C corp and an S corp are two quite different animals.
Earnings from a C company are subject to taxation and must be recorded on Form the 1120S for federal tax reasons. Dividends paid out of after-tax earnings are subject to further taxation and must be shown on the shareholders’ individual tax filings. You may avoid this “double taxation” by filing your business as an S company. An S corp. enjoys the same legal status as a sole proprietorship or partnership. Shareholders are responsible for reporting and paying taxes on any gains (or losses) that are distributed to them by their S corporation.
Additionally, in many jurisdictions, S company earnings and losses are distributed directly to shareholders. Some states, however, tax S corporations twice.
Ownership
With a C company, you have additional options when it comes to selling stock. The Internal Revenue Service states that a company may not:
Owned by more than a hundred people
Distribute shares in different categories.
Owned by foreign nationals rather than Americans
Possession of a C- or S-corporation, LLC, partnership, or trust.
Because C companies are exempt from these regulations, they are free to expand. Having many types of stock allows a company to attract investors without giving up control of the company’s voting process.
Additional Benefits
Health, life, and disability insurance are all examples of perks that a corporation could offer its shareholders who also happen to be its employees. If offered to at least 70% of workers, the cost of a C-corporation can deduct such expenses and the shareholder need not pay tax on them.
If a shareholder holds more than 2% of the company’s shares, the S corporation cannot deduct the cost of providing the benefit, and the benefit is taxable to the shareholder.
Which Is Best for You?
S corp. elections are typically made by smaller businesses that are eligible under the law to be treated as such. There are some businesses that are better suited to the structure of a C corporation.
Generally speaking, the S company is not available to large organizations, startups with a lot of money and great aspirations, or firms with international stock sale plans. It may be advantageous for large corporations to have more than one hundred shareholders, to sell shares to investors who are not citizens or permanent residents of the United States, to allow ownership of shares by other entities (firms, LLCs, partnerships, trusts, etc.), and to issue multiple classes of stock.
While S companies are more frequent among smaller businesses due to possible tax benefits, C corporations have more leeway in terms of capital raising. However, there are a number of factors specific to your business that will determine whether a C corp. or an S corp. is more appropriate.