When forming a business, there are a few different types of business structures that you establish. From a sole proprietorship to an LLC to an S or C Corp, all certainly have their benefits and consequent drawbacks. Be it taxation based, as far as liability goes, even how ownership is structured, the type of entity you choose, largely depends upon your ultimate goals for the company. In this article, we look at the differences as well as the pros and cons of specifically the S Corp and C Corp.
The primary difference between the two entities is going to be how they relate to taxes. So with a C Corp, you will pay tax on the company's income as well as on the money you receive as an employee of the company. However, with an S Corp, the corporation itself is not required to pay taxes, rather, the owners will report all revenue and losses as personal income.
Some Key Differences…
Taxation is the main difference; there are also other key differentiators between an S and C Corp that you need to carefully weigh when trying to determine which structure is best suited to your business model.
- Formation — Generally speaking, when you do incorporate within your home state, you will automatically be incorporated as a C Corp. To go ahead and change to S Corp status will require some additional IRS based paperwork. You also want to check with your attorney to see what other documents may be required.
- Taxation — As already noted, a C Corp essentially is taxed twice. So, you will pay corporate tax and then owners will pay tax on dividends/income. S Corps on the other hand have a pass-through tax structure. The only taxes paid are those that the owners pay in terms of their returns. No direct corporate taxation is involved with an S Corp.
- Ownership — As far as ownership of the business goes, with a C Corp, there are no restrictions in place. That is to say, there can be as many owners as you like. With an S Corp, on the other hand, there can only be up to one hundred shareholders and all must be citizens of the US.
Advantages and Disadvantages
When it comes to S Corp's formation, it is a bit lengthier process than your experience with a C Corp, which is much easier to set up. Because a C Corp is the default entity, you're not required to fill out any more paperwork or jump through any additional hoops.
The advantage of the S Corp as far as offering the pass-through tax option will be attractive to many. All owners report their income and consequent losses as part of their returns. You thereby get away from having to pay corporate taxes altogether. As far as the C Corp and taxes go, there is the double taxation disadvantage. They can though deduct 100% of charitable donations and contributions.
While yes, there are limitations with ownership in the S Corp structure, this may not necessarily be a bad thing. Depending on how you want the company to be controlled and managed. The number of shareholders is limited and also there is no difference in the types of shareholders. If however, you're looking for investor funding, the C Corp option may be the better bet, as there are no limitations. It thus becomes easier, in this structure, to sell as much stock as you wish.
The Similarities Between the Two
There are certain things that the two entities have in common. It is important to take a look at the future direction of the company to figure out which structure is the better one for you.
Limited liability protection
Both types of corporations offer limited liability protection. This essentially means that owners are protected from any financial obligations and/or legal issues that might arise within the context of the company. With sole proprietorships for example, if the company gets sued, the owner is on the hook personally. However, with the cooperate structure, the owners do not have to pay out of their own pockets for any debts or liability issues that arise.
Separate legal entities
Both structures can utilize separate legal entities—when a company splits off from the original company and operates separately. This again is another layer of liability protection available to both C and S Corps.
Though there are a couple of differences, both for the most part have very similar corporate structures. A CEO and their team manage the business, while a Board of Directors will handle the overarching management issues and many policies based decisions.
Which is the best option for you?
As mentioned, C Corp is the default status when incorporating, but this does not mean you cannot take steps to become an S Corp. Some things you might want to keep in mind when deciding between the two…Are you hoping to sell the company eventually? If the answer here is yes, then you're likely going to want to remain as a C Corp. C Corps can be owned by other kinds of companies and so acquisition overall is much easier. Also, are you looking to limit the number of shareholders? This of course would prompt you to become an S Corp. They are limited to 100 shareholders and tend to involve a smaller overall dynamic to this end.
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