When deciding on the right business structure for your startup, understanding the difference between a C Corp and an S Corp is crucial. These two corporation types offer distinct advantages and disadvantages that can impact taxes, ownership, and operations. This guide will help you understand the key differences between a C Corp and an S Corp so you can make an informed decision for your business.
What is a C Corporation (C Corp)?
A C Corporation, or C Corp, is a legal entity that exists separately from its owners (shareholders). This business structure is commonly chosen by larger companies due to its ability to attract investors, offer unlimited ownership, and protect shareholders from personal liability. Here are the main features of a C Corp:
- Taxation: A C Corp is subject to “double taxation.” The corporation pays corporate income taxes on its profits, and shareholders also pay taxes on dividends received from the company or via payroll if a shareholder is an employee.
- Ownership: C Corps can have an unlimited number of shareholders, and ownership can include foreign investors, other corporations, and even partnerships.
- Structure: C Corps are required to have a board of directors, officers, and formal bylaws. They must also hold annual meetings and follow specific reporting and governance protocols.
What is an S Corporation (S Corp)?
An S Corporation, or S Corp, is a special tax status granted to a corporation by the IRS. This structure provides the benefits of limited liability and avoids double taxation by passing corporate income directly to the shareholders, who report it on their personal tax returns. The key features of an S Corp include:
- Taxation: S Corps are considered “pass-through” entities for tax purposes, meaning corporate profits and losses are passed directly to shareholders, who report them on their personal tax returns. This avoids the double taxation seen with C Corps.
- Ownership: S Corps are limited to 100 shareholders, all of whom must be U.S. citizens or residents. Additionally, S Corps cannot have shareholders who are other corporations or partnerships.
- Structure: Like C Corps, S Corps must have a board of directors, officers, and formal bylaws. However, they enjoy simpler reporting requirements compared to C Corps.
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Key Differences Between a C Corp and an S Corp
Now that we’ve covered the basics of each corporation type, let’s dive deeper into the key differences:
Taxation
- C Corp: Subject to double taxation—first at the corporate level, and again on shareholder dividends or payroll. The corporate tax rate is currently 21%.
- S Corp: Passes income directly to shareholders, avoiding double taxation. Shareholders report their share of profits or losses on their personal tax returns.
Ownership Restrictions
- C Corp: No restrictions on the number of shareholders or who can be a shareholder. C Corps can have foreign shareholders, other corporations, or partnerships as owners.
- S Corp: Limited to 100 shareholders, and all must be U.S. citizens or residents. Ownership is limited to individuals, certain trusts, and estates.
Stock and Classes of Shares
- C Corp: Can issue multiple classes of stock (common and preferred), which can appeal to different types of investors.
- S Corp: Can only issue one class of stock, which may limit its ability to attract certain investors.
Corporate Formalities
- C Corp: Must adhere to strict formalities, including annual meetings, detailed record-keeping, and extensive compliance reporting.
- S Corp: Also requires formalities like annual meetings and record-keeping, but generally enjoys simpler compliance requirements.
How to Choose Between a C Corp and an S Corp
The difference between a C Corp and an S Corp boils down to ownership structure, taxation, and administrative requirements. Here are some factors to consider when choosing between the two:
- Taxation: If your business plans to reinvest profits and doesn’t plan to distribute dividends, a C Corp might offer advantages. However, if you want to avoid double taxation and pass profits directly to owners, an S Corp may be a better fit. If you are a very high earner, your tax rate could be greater than 30%. The C Corp tax rate is currently 21%, so if you are a very high earner you may actually save on taxes by being a C Corp and deferring income.
- Ownership: If you want the flexibility to attract an unlimited number of shareholders, including foreign investors or other corporations, a C Corp is the way to go. On the other hand, if you have a smaller ownership group that qualifies under the S Corp requirements, an S Corp might be more advantageous.
- Growth Potential: If you’re seeking venture capital or planning to go public, a C Corp is the preferred structure due to its ability to issue multiple classes of stock and offer more flexibility in ownership.
Conclusion
Understanding the key differences between a C Corp and an S Corp is essential for making the right decision for your business. While a C Corp offers advantages like unlimited shareholders and easier access to capital, it comes with the burden of double taxation. On the other hand, an S Corp can help you avoid double taxation but comes with ownership restrictions.
Ultimately, the right choice depends on your business goals, ownership structure, and tax preferences. Consulting with an accountant or tax advisor can help you determine which structure aligns with your business needs.
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About the Author
Brett Rosenstein
Founder of Build Accounting
Certified Public Accountant
Brett is the founder and president of Build Accounting where he provides accounting, tax filing, and CFO services for tech startups and SaaS businesses. His goal is to make the accounting and tax process as simple, streamlined, and headache-free for business founders as possible.
Brett received a Bachelor of Science in Business Administration from The Ohio State University. He is also a Certified Public Accountant.
When Brett is not working, he is running, biking, spending time with his wife and daughter, or trying new pizza places.
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