3 Important Differences Between S Corps and C Corps

When you are forming a small business, one of the decisions you will have to make is which corporate structure you should use. In many cases, small businesses elect to form a corporation simply because of the liability protection benefits offered. While S corporations and C corporations both offer liability protections and have other similarities, there are also some significant differences you need to be aware of.

Similarities Between S Corps and C Corps

Both corporate structure types offer the owners some liability protection; the owners of the corporation and their shareholders are typically not held liable for the debts incurred in the process of doing business. Other similarities include:

  • Corporate requirements – S corps and C corps require annual meetings of the board and shareholders, specific annual corporate filings, and the adoption of by-laws. Both structures also issue stock and are required to pay annual fees, generally within their state.
  • Legal structure – S corps and C corps are considered separate legal entities. State filings determine which formation is being used; the IRS requires a “declaration” if the business is considered an S corporation.
  • Legal documents – Both types of corporations are required to file articles of incorporation and by-laws within the state in which they are formed. This is standard regardless of which type of corporation you are forming.
  • Governing bodies – Both S corporations and C corporations are governed by boards of directors. In addition, both have shareholders and owners; board members generally elect the corporate officers who will handle the day-to-day operations of the company.

Differences Between S Corps and C Corps

While the similarities between S Corps and C Corps may appear to be beneficial, there are some differences that are extremely important to keep in mind. These differences appear in three distinct areas of the business including:

  • Number of shareholders
  • Taxation of business profits
  • Rights extended to shareholders

Before determining which business entity is best for your small business, it is important to take these differences into consideration.

Limits on Shareholders

Under the C corporation structure, a business entity may have as many shareholders as is feasible. For example, many large, publicly traded companies issue additional shares to raise money for their company. Smaller businesses may issue additional shares to obtain venture capital or other forms of capital for their business. However, with an S corporation structure, there is a limit of 100 shareholders who may own stock in the company.  S corporations must be owned by individuals who are U.S. citizens, versus C corporations which may have stock owned by individuals, other corporations, and partnerships.

Taxes on Business Profits

Perhaps the most significant difference between these two corporate structures is the taxation of profits. When you own an S corporation, the income of the company flows through to the shareholders and owners and is taxed at the personal level. S corporations file an annual tax return using Form 1120S which is merely an informational return. S corporations have no company tax liability; all dividends paid to shareholders and salaries paid to owners and others are taxed at the personal level.

On the other hand, a C corporation does have specific tax liabilities. The profits of the corporation are taxed at the corporate level, and they are also taxed at the personal level when shareholders pay taxes on dividends and corporate officers and others receiving a salary file their taxes.  Taxes are filed using Form 1120. It is important to consider the double taxation aspect of a C corporation when you are forming your business.

Not All Shareholders Are Equal

When you use an S corporation, there is a single class of stock and each shareholder is treated in the same manner for purposes of distributing dividends and profits. The same is not true for C corporations; different classes of stock may be issued depending on who will hold that stock. It is fairly common for corporate founders and investors to have a “higher” class of stock than the bulk of other shareholders.

Generally, there is preference given regarding the distribution of profits and dividends based on the class of stock issued. In addition, the higher classes of stock often give voting preference to founders and investors. Because of the flexibility of issuing different classes of stock, as a rule of thumb, C corporations often have an easier time raising capital through issuing new stock or issuing bonds because they are able to expand their ownership base.

While there are some similarities between a C corp and an S corp, the differences can be significant. While a C corporation is allowed to post losses on its tax returns, business losses in an S corporation pass through to the owners and shareholders. For many small business owners, an S corporation is preferable; however as companies expand and their need for capital grows, they often need to decide if a C corporation is more beneficial for their needs.

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