Choosing the right type of corporation is a critical decision that will shape the foundation of your business. It impacts everything from daily operations to taxation. Two of the most popular types of corporations are S Corporations (S Corp) and C Corporations (C Corp). Understanding the differences between them will help you determine which is best for your business goals.
What is an S-Corp?
An S Corporation, or S Corp, is often chosen by small businesses due to its limitations on the number of shareholders and the fact that it can issue only one class of stock.
Tax Liabilities
One of the key distinctions between a C Corp and an S Corp is how they are taxed. In an S Corp, income, losses, deductions, and credits are passed directly to shareholders. This allows the S Corp to avoid paying corporate income tax, as profits are reported on the shareholders’ personal tax returns. In contrast, a C Corp is taxed at both the corporate and shareholder levels.
Because of this pass-through taxation, shareholders of an S Corp are responsible for reporting and paying taxes on the corporation’s profits on their individual tax returns. This setup is similar to partnerships but with the benefits that corporations typically enjoy, such as limited liability protection.
However, the IRS scrutinizes S Corps closely to prevent tax evasion. Since shareholders are responsible for the company’s tax obligations, the IRS monitors the flow of profits and losses more rigorously than with other corporation types.
Shareholders
S Corporations have strict restrictions on who can be a shareholder. Only individuals, certain trusts, estates, and non-profit organizations are eligible. Corporate entities and partnerships are excluded from holding shares in an S Corp. Additionally, the number of shareholders is capped at 100, limiting the corporation’s ability to expand.
How to Form an S Corp
To form an S Corp, you must file Articles of Incorporation (AOI) and IRS Form 2553. Only U.S. citizens or permanent residents can be incorporators, and as previously mentioned, there can be no more than 100 shareholders, all of whom must be individuals, trusts, estates, or non-profits.
If you’re unsure if an S Corp is the right fit for your business, the Oracle Legal Group is available to provide expert advice on the legal implications and tax advantages of an S Corporation.
What is a C Corp?
A C Corporation, or C Corp, is the default type of corporation in the U.S. It’s what most people think of when they hear the word “corporation.” In a C Corp, management is separate from the shareholders, who can be individuals or entities that own part of the company.
Tax Liabilities
C Corporations are subject to “double taxation.” This means that the company pays corporate income tax at the federal level (currently at a 21% tax rate), and when shareholders receive dividends, they are taxed again at the individual level. This differs significantly from the S Corp structure, where only shareholders are taxed, avoiding corporate taxes.
However, while C Corps are taxed more heavily, they offer greater growth potential, including the ability to raise capital by issuing multiple classes of stock, which is prohibited for S Corps.
Shareholders
Unlike S Corps, C Corps are not restricted in the number or type of shareholders. Corporations, foreign investors, and partnerships can all own shares in a C Corp, making it the ideal structure for businesses looking to scale significantly. The unlimited number of shareholders allows for substantial growth, which can be vital for businesses seeking outside investment or aiming to go public.
How to Form a C Corp
To form a C Corp, you’ll need to file Articles of Incorporation with the state and register with the Securities and Exchange Commission (SEC). C Corps must comply with various regulatory requirements, including holding annual shareholder meetings and filing financial statements. While this can be more costly and time-consuming compared to S Corps, these regulations provide additional structure and accountability, which may be appealing to investors.
S Corp vs C Corp: Which is Right for You?
The key differences between an S Corp and a C Corp come down to taxation, shareholder restrictions, and growth potential.
- Taxation: An S Corp avoids double taxation by passing profits directly to shareholders, who then pay personal income tax. In contrast, a C Corp is taxed at both the corporate and shareholder levels.
- Shareholders: S Corps have strict shareholder limitations—no more than 100 shareholders and only certain entities qualify. A C Corp has no such restrictions, making it the better option for businesses that plan to scale or attract outside investment.
- Complexity: While C Corps offer more growth opportunities, they also come with more legal and financial obligations, including additional filings, meetings, and regulatory requirements.
When deciding between a C Corp or S Corp, consider your long-term business goals, growth potential, and tax situation. Each structure offers unique advantages and limitations that could significantly impact the future success of your business.
If you need further assistance in understanding the difference between a C Corp and an S Corp, contact the Oracle Legal Group. Our team of experts is ready to assist you in making the right choice for your business needs.
