#37 Decoding the Difference: S Corporation vs. C Corporation – Which Is Right for Your Business?

C Corporation vs. S Corporation: Key Differences and Considerations

Overview:

The C corporation is the default corporate structure under IRS rules, while the S corporation has opted for a special tax status with the IRS, offering specific tax advantages. Both structures derive their names from the sections of the Internal Revenue Code under which they are taxed: C corporations fall under Subchapter C, while S corporations fall under Subchapter S. To elect S corporation status, Form 2553 must be filed with the IRS, and all S corporation guidelines must be met.

Common Features of C and S Corporations:

• Limited Liability Protection: Both C and S corporations offer limited liability protection, meaning shareholders are generally not personally liable for business debts and liabilities.
• Separate Legal Entities: Both types of corporations are legally separate entities created by state filing.
• Filing Documents: Formation documents, such as Articles of Incorporation or Certificate of Incorporation, must be filed with the state, irrespective of the tax status.
• Structure: Both types have shareholders, directors, and officers. Shareholders own the corporation, directors oversee corporate affairs, and officers manage daily operations.
• Corporate Formalities: Both C and S corporations must adhere to corporate formalities including adopting bylaws, issuing stock, holding meetings, maintaining a registered agent, filing annual reports, and paying annual fees.

Differences Between S Corporations and C Corporations:

1. Taxation:

   • C Corporations: Taxed as separate entities, filing a corporate tax return (Form 1120). They face potential double taxation: first at the corporate level and again on dividends received by shareholders.
   • S Corporations: Benefit from pass-through taxation. They file an informational federal return (Form 1120S), and the profits and losses pass through to shareholders' personal tax returns, avoiding corporate-level tax.

2. Personal Income Taxes: Both C and S corporations require personal income tax on salaries and dividends.

3. Corporate Ownership:

   • S Corporations: Limited to 100 shareholders, who must be U.S. citizens or residents. They cannot be owned by C corporations, other S corporations (with some exceptions), LLCs, partnerships, or many trusts. They can only have one class of stock.
   • C Corporations: No limits on the number or type of shareholders. They can have multiple classes of stock.

Advantages and Disadvantages:

• S Corporation Advantages:

  • Single layer of taxation.
  • 20% qualified business income deduction (under the Tax Cuts and Jobs Act of 2017).
  • Pass-through of losses.

• S Corporation Disadvantages:

  • Limited to 100 shareholders.
  • Shareholders must be individuals and U.S. residents.
  • No preferred stock allowed.
  • Transfer restrictions may complicate shareholder exit.

• C Corporation Advantages:

  • No limit on the number of shareholders.
  • No restrictions on ownership.
  • Multiple classes of stock allowed.
  • Lower maximum tax rate (21% as of the 2017 Tax Cuts and Jobs Act).
  • More options for raising capital.

• C Corporation Disadvantages:

  • Double taxation on earnings.

Choosing Between S Corp and C Corp:

When S Corp Advantages Outweigh the Disadvantages:

• If planning to avoid an IPO and not seeking more than 100 shareholders.
• When distributing income to shareholders.
• If not issuing preferred stock.
• If the pass-through taxation provides a better tax outcome.

When C Corp Advantages Outweigh the Disadvantages:

• If the C corporation tax rate results in lower overall taxes.
• When planning an IPO or seeking investors not allowed for S corporations.
• If preferring freely transferable shares and issuing preferred stock.

Formation and Election:

• Forming a C Corporation: File Articles of Incorporation with the state. The corporation is taxed under Subchapter C unless a different election is made.
• Becoming an S Corporation: After forming a corporation, file Form 2553 with the IRS to elect S corporation status.

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