S Corporation vs. Corporation: Which Should You Choose?
When you start or grow a company, the business structure you choose can have significant implications on everything from the taxes you pay to how the business is owned or operated.
If you’re considering starting a new corporation or changing your entity type, it’s important to understand the differences in S-corps and C-corps. The two have some key similarities — including potentially offering more liability protection than an LLC — but differ in taxation and stock restrictions.
S corporations vs C corporations: Key differences
There are key differences between S corporations and C corporations that will affect how you pay taxes, who owns the company and potential restrictions around stocks or shareholders.
S corporations have more restrictions and eligibility requirements, but they also offer significant tax benefits as a pass-through entity. C corporations, meanwhile, don’t place limitations on stock option classes or shareholders, but can result in double taxation.
| S Corporation | C Corporation | |
|---|---|---|
| Biggest pro | Single layer of taxation as a pass-through entity | No limits placed on stock option classes or number of shareholders |
| Biggest con | Restrictions on stocks and number of shareholders | Double taxation |
| Stock restrictions | Yes | No |
| Shareholder restrictions | Yes | No |
| Taxes | Pass-through tax entity with a single layer of taxation | Entirely separate taxable entities |
| Liability | Liability protection offered to owners and shareholders (in most cases) | Liability protection offered to owners and shareholders (in most cases) |
| How to form |
|
|
What is an S corporation?
An S corporation is a type of corporation (or business entity) that elects to pass most corporate income, deductions, credits and losses through to their shareholders for federal tax purposes. While you’ll still need to file a business tax return, the income itself can be passed through to a personal tax return. This flexibility may help reduce your overall tax burden.
This is called a pass-through entity, allowing shareholders to report the income and losses on their personal tax returns. This means the assessed tax occurs at their individual income rates, preventing double taxation that can occur with C corporations.
Your company must meet the following eligibility requirements to become an S corporation status:
- Be domestic
- Must have shareholders that are either individuals, estates, or certain types of trusts
- Have no more than 100 shareholders
- Have only a single class of stock
- Be an eligible corporation
Pros and cons of S-corps
S-corps have both pros and cons.
The most significant pros of S-corps include:
- Pass-through entity structure for greater flexibility.
- Self-employment taxes are lower than corporate tax rates.
- Single taxation, avoiding the double taxation that occurs with C-corps.
- Liability protection is afforded to owners in most cases, as the corporation is a separate legal entity — similar to C-corps
The downsides of S-corps include:
- More stringent eligibility requirements compared to C-corps.
- Limited to only 100 shareholders, which can impact company growth and fundraising.
- You’re limited to a single class of stock.
- Filing to elect to be taxed as an S-corp requires an extra step.
- Detailed financial reporting is required compared to other business entities (though this is also true for C-corps).
- Must operate domestically.
When is an S corporation the best choice?
According to the U.S. Small Business Administration, an S corporation election may be a strong choice for any company that would otherwise be a C-corp but meets the criteria for an S-corp. The ability to avoid double taxation is an incredibly advantageous benefit for business owners.
An S-corp may be the best choice if your business:
- Does not plan to grow through aggressive stock sales to new shareholders
- Wants to avoid double taxation
- Is currently an LLC that wants increased tax benefits or additional liability protection
How to become an S corporation
To become an S corporation, you can follow these steps:
- Choose a name for your business.
- File articles of incorporation with your state.
- Request your EIN through the IRS.
- Elect a board of directors (but note that you can have a single owner if you choose).
- Write bylaws for governance.
- Submit Form 2553 (signed by all shareholders) with the IRS to receive S-corp election.
What is a C corporation?
A C corporation is a legal business entity that’s entirely separate from its owners. It’s owned by shareholders, and it has exceptional growth potential. For this reason, many large companies and public companies are initially formed as C-corps or later converted to them.
While C corporations have unlimited growth potential thanks to the sale of diverse classes of stocks and no restrictions around shareholders, it is subject to double taxation. This means that the company is first taxed at the federal corporate tax rate, which is currently 21%. Then, dividends or profits passed to shareholders are taxed a second time as personal income.
Like S corporations, C corporations require ongoing and detailed financial reporting.
Pros and cons of C-corps
Just as with S corporations, there are both advantages and disadvantages to consider with C corporations.
The most significant pros of C-corps include:
- Unlimited growth potential
- No restrictions on number or types of shareholders
- Less stringent eligibility requirements
- Multiple classes of stock options available
- Can be highly beneficial for growth-oriented companies who want to raise funds through stocks
- Well suited for companies that want to go public
- Offers personal liability protection in most cases, like an S-corp
- Completely separate from shareholders, allowing shareholders to leave the company or sell the shares without disrupting the business
The cons that you should consider include:
- Double taxation, which can greatly impact your tax burden
- More regulations and reporting responsibilities, including keeping bylaws and voting records documented
- Stricter management requirements may involve a board of directors and managers that are separate entities
When is a C corporation the best choice?
While there are tax advantages for businesses that elect to be taxed as S corporations, there are several cases when C-corp incorporation makes the most sense. These instances include:
- You plan to grow or become a public company.
- You want to raise funds through stocks.
- You want to eventually sell the company.
- You have a medium- or high-risk business that could benefit from more liability protection.
- You don’t meet the S-corp requirements, such as having more than 100 shareholders or having shareholders that are corporations.
- Your organization isn’t entirely run domestically.
How to become a C corporation
To form a C corporation, take these steps:
- Choose a name for your business and register it with the state.
- Appoint corporate officers, including a chief executive officer (CEO) and a board of directors.
- Incorporate through the state where the company is registered.
- Request an EIN through the IRS’s website.
- Write the company’s bylaws of governance.
- Issue stock certificates to shareholders.
Both S corporations and C corporations offer some liability protection, but it’s not unlimited. Because the company is considered a separate entity, your personal assets are usually safe if your business is sued or defaults on a loan.
But if you don’t treat the business like a separate entity — like if you mix your personal and business finances or don’t stay in compliance with the regulations for corporations — you can lose those protections.
You can also sign away your ability to avoid liability. For example, if you personally guarantee a loan for the business, you can be held responsible for it if the business can’t pay.
You’re also still responsible for your personal actions. So if you personally injure someone or commit fraud, for example, you can still be held responsible.
How to choose the right business structure
Choosing the right business entity can feel intimidating, especially since there’s no one “right answer” regarding whether an S-corp versus a C-corp is better.
It’s essential to consider your current business objectives and your long-term growth goals. Many single-member LLCs, for example, elect to become taxed as an S corporation for the tax benefits. An S-corp election allows them to keep the benefits of a pass-through entity and avoid double taxation.
Companies that plan to grow aggressively through fundraising, meanwhile, would likely benefit more from a C corporation election since they can raise funds through the sales of stocks. They’re also a good choice for businesses that want to go public.
Talk to a tax professional to discuss your current revenue and long-term goals. They can help you determine which business structure is most advantageous according to tax implications, shareholder restrictions and stock restrictions.
Can I change my business structure later?
Yes, you can change your business structure down the road.
To change from an S-corp to a C-corp, you’ll need to file a Statement of Revocation with the IRS service center. This must include:
- Your company name and tax ID number
- The date on which your tax year ends
- The date of the S-corp status revocation
- The number of outstanding shares
- The names, addresses, and tax ID numbers of shareholders
- Statement of consent signed by stakeholders who own more than 50% of the company stock
And to change from a C-corp to an S-corp, you have to:
- Utilize Form 2553.
- Receive an acknowledgment from the IRS of your new election status
- File the last C-corp return by the due date, or request an extension
- File the S- corp return by the due date, which finalizes the change in election status
How long does it take to incorporate?
Incorporating a business is often a relatively quick process. The exact time it takes to incorporate a business depends on the state where you’ll operate and their individual processes. It may take anywhere from a few days to over a month.
After your state approves your application of incorporation, you’ll need to file for an EIN with the IRS. When you apply online, you can receive an EIN immediately.
After this, you can follow the necessary steps according to your specific business structure, which may involve an S-corp election or appointing shareholders.
Other business entities to consider
While S corporations and C corporations are two popular business structures, there are other types of business entities to consider. These include:
- Limited liability companies (LLCs). Owned by one or more members, this is a popular business structure that offers limited liability protection and pass-through entity benefits.
- Sole proprietorships. An individual who owns an unincorporated business. While sole proprietorships are simple to form and don’t require you to file business tax returns, they don’t allow for any liability protection.
- Partnerships. Owned by two or more members, partnerships are business structures that involve multiple contributing parties. The partnership as an entity must file an informational return.
A tax professional can help you determine which option is most beneficial for your business based on current revenue, projected financial growth and long-term goals.
Compare business loan offers
Read More
LLC vs. Corporation: What’s the Difference? Updated December 30, 2024 Although some aspects of the two entities are similar, there are distinct differences when it…Read More