What’s the Difference Between a C vs S Corporation?
At first glance, the difference between a C Corporation and S Corporation seems to be negligible. After all, both structures follow the same organizational framework in that a board of directors oversees major decisions and an executive runs the daily operation.
However, they differ in three key areas: taxation, ownership flexibility, and scale of operations.
Let’s dive in.
The biggest difference between a C vs S corporation is how the businesses are taxed.
Simply put, all corporations must pay federal income tax based on the revenue they generate. But whereas S Corporations are only taxed once, C Corporations are taxed twice, a financial arrangement known as double taxation on those with a C Corp EIN.
C Corporations are taxed twice because unlike S Corporations, their incomes aren’t passed directly to their owners. Rather, the taxable income stays with the corporation, making the corporate income taxable. The corporation then pays an additional corporate income tax when it distributes dividends because the business owner must pay taxes on those dividends.
In short, S Corporations have more tax-saving because the S corp owner is the one paying—not the corporation itself. However, though S Corporations save money, there are a few restrictions:
- S Corps are limited to no more than 100 shareholders.
- All shareholders must be U.S. citizens and can only hold one class of stock.
- Shareholders can’t deduct the cost of fringe benefits from their overall tax liability.
Regardless of which business structure you choose, you may need help with your taxes. Consider using intelligent form filling and automated tools to make reporting your 1120-W Form (estimated tax for corporations) as stress-free as possible.
#2 Ownership Flexibility
If a C Corporation is on the losing side in terms of taxation, it’s on the winning side when it comes to flexibility. This is because of the shareholder requirements mentioned above.
While an S Corporation is limited to 100 shareholders, a C Corporation can have an unlimited number of shareholders. Furthermore, the shareholders of a C Corporation don’t have to be U.S. citizens, making the pool of investors much larger for a C Corporation than an S Corporation.
#3 Scale of Operations
In general, S Corporations are more suited to smaller, more established businesses rather than newer businesses. This is because S Corporations allow businesses to distribute profits straight to the business owner without the headache of double taxation.
On the other hand, C Corporations tend to be larger, newer businesses. These are corporations whose profits are likely to be reinvested back into the company.
At first glance, this distinction seems to defy common sense—shouldn’t emerging businesses want to reduce taxes as a way to offset first-year profit loss?
Remember: although S Corporations are paying less in taxes they’re paying more in shareholder restrictions. C Corporations benefit larger, thriving businesses because it gives them access to larger investor bases.
Which Structure to Choose
Although C Corporations and S Corporations are distinct business structures, the choice between them is a bit misleading. The fact is that all businesses are C Corporations when they first incorporate. An S Corporation is really a special tax designation that businesses can apply for.
The question thus becomes: should your C Corporation become an S Corporation?
To answer this question, take the following considerations into account:
- Business age and size – Because S Corporations aren’t doubly taxed, S Corporations greatly benefit small businesses that are more focused on streamlining profits to owners. However, if you’re a newer, growing business, the greater investor base afforded to C Corporations may be a bigger benefit than reduced taxes.
- Ownership structure – If your business has less than 100 shareholders and they’re all U.S. citizens, an S Corporation may be for you. However, you should know that some businesses, such as banks and insurance companies, aren’t eligible to become S Corporations. In short, C Corporations give businesses more flexibility.
- Self-employment tax – In addition to no double tax, S Corporations give small business owners another major advantage: a reduced self-employment tax. This is because the S Corporation tax designation means that business owners must only pay taxes on what they give themselves in the form of a “reasonable salary.” However, business owners should know that it’s important to be able to justify your salary in case you’re audited by the IRS.
Deciding between an S vs C corp can be difficult. While an S Corporation designation means you’ll pay less in taxes, a C Corporation gives you greater flexibility.
CFI. What is C Corp vs S Corp? https://corporatefinanceinstitute.com/resources/knowledge/strategy/c-corp-vs-s-corp/
Bench. S Corp vs C Corp (Advantages and Disadvantages). https://bench.co/blog/tax-tips/s-corp-vs-c-corp/#:~:text=As%20we%20mentioned%20above%2C%20C%20corporation%20income%20is,as%20an%20S%20corp%20than%20a%20C%20corp.
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