If you’re hoping to organize your small business as a corporation, there are a number of business structures your company could pursue. Some of the most common structures for incorporated businesses are LLCs, S Corps, and C Corps. While there are some similarities across these designations, there are important differences to consider.
While S Corps and C Corps are very similar in name and organization, the two business structures affect your business’s growth, cash flow, and taxation. The biggest difference between C and S corporations is that C Corporations pay tax on their income, plus a tax on income received as an owner or employee. S corps on the other hand do not pay tax as the owners report the company revenue as personal income.
Read on for a quick overview of the similarities and differences between an s corp and c corp designation, as well as the potential benefits and drawbacks of either option for your business.
The Difference Between S Corp and C Corp
There are three big differences between an S Corp and a C corp: taxation, ownership, and formation. The difference in taxation has the most impact for the majority of small business owners.
Taxation: C corp owners pay both personal and business income taxes, while S Corp owners only pay personal income taxes.
Formation: When a business files for incorporation, the default incorporation structure is a C Corp. To be established as an S Corp, business owners must file additional paperwork.
Ownership: C corps can have unlimited shareholders around the globe and can issue multiple classes of stock, which S Corps can only have 100 shareholders, all of whom must be U.S. citizens.
Here’s the nitty-gritty on the differences (and similarities) between S Corporations and C Corporations.
When launching your small business as an S or C corporation, you and your fellow owners will need to file articles of incorporation and draft your company bylaws. By default, you will be designated as a C Corporation if your application is approved. In order to classify as an S Corp, and to receive the tax benefits of doing so, you must go through further scrutiny from the IRS.
First, IRS Form 2553 must be submitted and approved. Then, because your would-be S Corporation will avoid income taxation, the IRS will dig into your business records and history to ensure that you are in compliance with the S Corp ownership regulations and that your business is fit for the designation.
Additionally, there are hurdles to receiving S corporation designation as it relates to your firm’s ownership. Where C Corps are free to issue multiple classes of stock on the global market, S corps are restricted in the number and type of shareholders they may have. S Corporations must have no more than 100 shareholders, all of whom must be U.S Citizens.
Only individuals, estates, or trusts may act as shareholders in the organization, and other companies and organizations cannot purchase stock in your company. This requirement can restrict S Corps from experiencing rapid globalization and expansion but is a reasonable price to pay for the benefits of becoming an S corp.
Despite the extra paperwork and organizational restrictions, many small business owners hope to classify their startups as S corporations. This is largely because of the differences in taxation between S and C Corporations. While C corp owners pay both business taxes and personal income taxes, S corp owners can file any company revenue or business debts in their personal income statements for that year. Effectively, this means that achieving the status of S Corporations gives you and your business partners a fairly significant tax cut when it comes time to file annual reports and returns.
S Corp and C Corp Similarities
Beyond the differences outlined above, there are actually more similarities than variations between S Corporations and C Corporations. Both designations are forms of incorporation, which establishes your business as a legal entity and creates a separation between the entity and its ownership. Incorporating your business is a smart move if you aim to launch your company with as little risk to your personal assets as possible. By establishing a formal dichotomy between the business entity and its owners, you and your partners negate the risk of your own personal assets being seized in the case of defaults or litigation.
An LLC, or limited liability company, is another great option for those hoping to protect their personal assets when starting a business. LLCs allow you to receive similar protections as S Corp and C corp statuses, but without the added paperwork or potential tax breaks. While there are differences as it relates to formation, ownership, and taxation, LLCs, C corps, and S corps have more similarities than differences in what they offer business owners. Carefully consider the benefits and drawbacks of each option before deciding on your corporate structure, as this choice can impact your margins and growth for years to come.