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Are you setting up your business entity as a corporation? If so, you’ll have to decide between registering as an S Corp vs a C Corp.
Now, you may believe this is not much of a concern. After all, you can just hire a lawyer or accountant to deal with these types of forms. Why should you bother with doing the research yourself?
Unfortunately, it’s not that simple. The choice of setting up as a C or S corporation can have a major impact on your business. It influences your abilities to pay taxes, raise money, and expand your business.
All things considered, it’s worth knowing what sets these two business entities apart. That way, you’ll be able to make an informed decision on which one is the right fit for your needs. Here are the main things you should be aware of.
Similarities
Before noting the differences between C Corps and S Corps, let’s look at what they have in common.
In both business entities, the owners are also shareholders. They’re the ones who elect directors tasked with overseeing business operations. The directors then elect officers for managing the daily business affairs.
Both types of corporations must follow similar corporate obligations and formalities. These include adopting by-laws, issuing stock, and paying annual fees. They’re also required to hold annual shareholder and director meetings.
Both S and C corporations offer limited liability protection. In other words, shareholders aren’t personally responsible for corporate debts assuming they act in good faith. As a corporation is a separate legal entity, only its assets are subject to corporate debts.
Finally, any formation documents should be filed with the state. These documents are known as articles of incorporation or certificate of incorporation. They are the same for both types of corporations.
Formation
The main difference between a C Corp and an S Corp is in their tax status.
Simply put, all corporations start out as C corporations. If you want to convert a C Corp to an S Corp, you’ll have to file IRS Form 2553. S corporations get their name from the Subchapter S of the IRC (Internal Revenue Code).
To elect S Corp status for a certain year, you must file Form 2553 by March 15th of that year. Of course, this is only true for corporations managed on a calendar year basis.
What do you do if you’re using an alternative fiscal year? In this case, you’re required to file Form 2553 by the 15th day of the third month of the year.
Taxation
Why would you restructure your business to an S corporation? In a word: taxes.
For federal tax purposes, C corporations are separate entities. They pay their taxes at a corporate level and file a corporate tax return.
Now, C Corps can also be subject to double taxation. This happens if corporate income is paid out to business owners (shareholders) as dividends. In this case, the corporation pays the taxes at both the corporate (21% flat rate under the new tax law) and individual level (23.8% max rate under the new tax law).
By comparison, S Corps are pass-through tax entities. Any profits pass through the business and are reported on the shareholders’ personal tax returns. In other words, taxes are only paid at the individual level.
For example, let’s say you’re the sole shareholder of your corporation and that you’ve made a profit of $100,000 and want to receive all of that profit as cash.
With a C Corp, you’d first pay a corporation tax of $21,000 (21%), receiving a dividend of $79,000. Then, you’d pay personal income tax on that dividend. With a tax rate of 23.8%, you’d pay $18,802, and your take home cash would decrease to $60,198.
With an S Corp, you’d receive the full $100,000 profit as a dividend (please keep in mind you may also need to pay yourself a reasonable amount of compensation as an officer of a S Corp). Assuming this was your only income (and not taking into account any standard or itemized deductions) your individual income tax rate would be 22% if you are a married filer. That means you would only pay tax of $22,000 and you’d still keep $78,000. This would save $17,802 in income taxes. This is not taking into account any reasonable compensation and the associated payroll taxes you may incur. This is the main factor in the S-Corp vs C-Corp debate.
Ownership
Corporate ownership is another major point of difference between C Corps and S Corps.
According to the IRS, S Corps can’t have more than 100 shareholders, and they must all be U.S. residents. Also, they can only issue one class of stock. Finally, S Corps can’t be owned by LLC’s, C Corps, partnerships, or certain trusts.
None of these restrictions apply to C Corps, which provide more flexibility. If you’re planning on growing your business, expanding the ownership or going public, a C Corp may be your best choice.
Making the Choice
Like most things in life, the C Corp vs S Corp decision is a matter of personal preference and your unique situation.
Due to the likely tax savings, most small businesses prefer the S Corp status. Of course, your business needs to fit within the legal limitations for an S Corp. In this regard, your choice may have already been made for you.
That said, it’s worth noting that some corporations would find more advantages with a C Corp.
As we’ve already mentioned, this status gives you more flexibility to raise capital. If you’re interested in selling stock globally or have a lot of start-up capital, you should go with a C Corp.
S Corp vs C Corp: Conclusion
As you can see, the S Corp vs C Corp debate is not an easy one.
No matter which of these business entities you opt for, you should be sure that you’ve made the right choice. Remember, your business structure can have major implications on your future. This is not a matter you should take lightly.
To be on the safe side, you should consult with a tax accountant before signing any documents. We at BRW Tax & Accounting can help you out with that. You can contact us right here, and we’ll get back to you as soon as possible.