S Corp vs C Corp: Difference and Comparison

S Corps are pass-through entities, meaning they avoid double taxation, while C Corps face double taxation with profits taxed at both corporate and shareholder levels. S Corps have restrictions on ownership and can’t have foreign shareholders, whereas C Corps have more flexibility in ownership and can attract foreign investors. S Corps are preferred for small businesses, while larger companies opt for C Corp status.

Key Takeaways

1. S Corps are pass-through entities, with profits and losses flowing to shareholders’ tax returns. C Corps face double taxation, with profits taxed at corporate and individual levels.
2. S Corps have stricter eligibility requirements, limited to 100 shareholders and one class of stock, while C Corps can have unlimited shareholders and multiple stock classes.
3. S Corps are beneficial for small businesses seeking to avoid double taxation. C Corps offer more flexibility in ownership and stock options, benefiting larger businesses or those seeking outside investment.

S Corp vs C Corp

The difference between S Corp and C Corp is that S Corp doesn’t pay taxes. C Corporation pays tax on its income.

S corporation is not a business entity type but a tax designation. You need to apply to IRS to become one of the S corporations. C Corp is a valid system for an organization. Shareholders or owners are taxed differently from the entity.

The shareholders of a C-Corp own the business, but they don’t make most of the decisions. The policy issues and management are left to the shareholder-elected board of directors.

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Comparison Table

Feature	S Corp	C Corp
Taxation	Pass-through entity; shareholders pay individual income tax on profits and losses	Double taxation; corporation pays corporate income tax, then shareholders pay individual income tax on dividends
Ownership	Maximum 100 shareholders, must be US citizens or resident aliens	No limit on number of shareholders, can include corporations and foreign investors
Share classes	Only one class of stock allowed	Can have multiple classes of stock with different voting and dividend rights
Formation requirements	Must file Form 2553 with IRS	File articles of incorporation with state
Annual reporting	File Form 1120S with IRS	File Form 1120 with IRS
Formal requirements	Annual board meetings and shareholder meetings required	Board meetings required, shareholder meetings less frequent
Profit sharing	Must distribute profits and losses proportionately to ownership stakes	Can retain profits within the corporation
Flexibility	Less flexible due to stricter ownership and distribution rules	More flexible in ownership structure and profit distribution
Suitability	For small businesses with few shareholders and predictable income	For larger businesses seeking capital or potential for explosive growth

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What is S Corp?

An S Corporation (S Corp) is a type of business entity that elects to pass corporate income, losses, deductions, and credits through to its shareholders for federal tax purposes. This means that the corporation itself does not pay federal income taxes; instead, its income or losses are passed on to the individual shareholders, who report the income on their personal tax returns.

Qualification and Election

To qualify for S Corporation status, a business must meet certain criteria, including being a domestic corporation, having only allowable shareholders (individuals, certain trusts, and estates), and not exceeding 100 shareholders. Additionally, all shareholders must be U.S. citizens or residents. To become an S Corp, the business must file Form 2553 with the Internal Revenue Service (IRS) after meeting the eligibility requirements.

Taxation and Avoidance of Double Taxation

One of the primary advantages of S Corporations is the avoidance of double taxation. Unlike C Corporations, where the corporate entity and shareholders are separately taxed, S Corps pass their income through to shareholders, who then report it on their individual tax returns. This pass-through taxation helps avoid the double taxation associated with C Corps, where profits are taxed at both the corporate and shareholder levels.

Limitations and Restrictions

S Corps have certain limitations, including restrictions on the types of shareholders they can have. For instance, non-resident aliens, other corporations, and certain types of trusts cannot be shareholders. S Corps are also limited to a maximum of 100 shareholders, and there can be only one class of stock. These restrictions can impact the flexibility of ownership and investment opportunities for the business.

Flexibility and Small Business Preference

Despite the limitations, S Corporations are popular among small businesses due to their tax advantages and simplified structure. Many entrepreneurs and small business owners find that the pass-through taxation and limited formalities make S Corps an attractive choice, especially when compared to the more complex structure of C Corporations.

 

What is C Corp?

A C Corporation, referred to as a C Corp, is a legal structure for a business that is treated as a separate entity from its owners (shareholders). This corporate structure is distinct due to its unique taxation and ownership characteristics.

Key Features of C Corporations

1. Limited Liability: Shareholders enjoy limited liability, meaning their personal assets are protected from the company’s debts and liabilities.
2. Separate Legal Entity: A C Corp is considered a separate legal entity, allowing it to enter contracts, own assets, and incur debts independently of its owners.
3. Perpetual Existence: The corporation exists independently of its shareholders, and changes in ownership or the death of a shareholder do not affect its continuity.
4. Double Taxation: One notable feature is double taxation. C Corporations are subject to corporate income tax on their profits, and shareholders are taxed on dividends received, resulting in taxation at both the corporate and individual levels.
5. Ease of Capital Raising: C Corps have the advantage of issuing multiple classes of stock, making it easier to attract investors and raise capital.
6. Complexity and Compliance: The structure involves more complex legal and administrative requirements, including annual meetings, formal record-keeping, and compliance with state regulations.
7. Ownership Flexibility: C Corps can have an unlimited number of shareholders, and ownership can be easily transferred through the buying and selling of stock.
8. Attractiveness to Investors: The corporate structure is preferred by venture capitalists and institutional investors, as it provides a clear framework for equity investment.
9. Employee Benefits: C Corps can offer various employee benefits, such as stock options and retirement plans, making it attractive for attracting and retaining talent.
10. Corporate Governance: C Corps have a structured corporate governance system with a board of directors overseeing major decisions, providing a formal structure for decision-making.

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Main Differences Between S Corp and C Corp

• Taxation:
  • C Corp: Subject to double taxation, with profits taxed at both corporate and shareholder levels.
  • S Corp: Pass-through taxation, where profits and losses flow through to shareholders, avoiding double taxation.
• Ownership Restrictions:
  • C Corp: No restrictions on ownership, allowing for various classes of stock and foreign shareholders.
  • S Corp: Restrictions on ownership, limited to 100 shareholders who must be U.S. citizens or residents, and no foreign ownership.
• Tax Filings:
  • C Corp: Files its own tax return (Form 1120) and pays corporate taxes.
  • S Corp: Passes income and losses through to shareholders, who report them on their individual tax returns (Form 1120S).
• Profit and Loss Allocation:
  • C Corp: Profits and losses remain within the corporation until distributed as dividends.
  • S Corp: Passes through profits and losses to shareholders annually, regardless of distribution.
• Flexibility:
  • C Corp: More flexible in structuring ownership, making it attractive for larger businesses and those seeking diverse ownership structures.
  • S Corp: Typically preferred by small to mid-sized businesses due to its simplicity and pass-through taxation.
• Perpetual Existence:
  • C Corp: Has perpetual existence, unaffected by changes in ownership or the death of shareholders.
  • S Corp: Ownership changes may impact the company’s existence, as it is closely held with limited shareholders.
• Employee Stock Options:
  • C Corp: Can issue various classes of stock, facilitating the use of stock options to attract and retain employees.
  • S Corp: Limited in the issuance of stock, which may affect the flexibility of employee stock option plans.
• Venture Capital and Investor Attraction:
  • C Corp: More attractive to venture capitalists and institutional investors due to the flexibility of ownership and clear equity framework.
  • S Corp: Typically preferred for businesses with a smaller number of shareholders, family-owned or closely held.
• Formalities and Compliance:
  • C Corp: Involves more complex legal and administrative requirements, including regular board meetings and formal record-keeping.
  • S Corp: Generally has simpler formalities and compliance obligations, making it more manageable for small businesses.

References

1. https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations