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There are several options to choose from when forming a legal business entity. If you want to start a corporation, you’ll need to choose between an S Corporation or C Corporation.
This in-depth guide will explain the advantages, drawbacks, taxation, formation process, and everything else you need to know about S corps and C corps—making it easier for you to decide which one is right for your business.
Why Understanding the Difference Between S-Corps vs. C-Corps Is So Important
It’s a common misconception that one type of corporation is better than the other. This is simply not true. There are plenty of instances where it makes sense to form an S corp, and just as many scenarios where a C corp is the better option.
Ultimately, deciding which one is “best” depends on your specific business, priorities, goals, and future aspirations.
The reason why this decision is so important is because your choice will ultimately impact how you pay taxes, how you can raise money, startup costs, and how easily you can grow your business.
If you make the wrong choice today, it could restrict your options down the road if you want to bring in outside investors or take your company public. On the flip side, the right decision today will ease your burdens down the road. You’ll have full control over your taxation, ownership rights, operations, and more.
Let’s take a closer look at the basics of S corps vs. C corps to learn more about the pros and cons of each:
S corporation is a tax status granted by the IRS. This special designation allows corporate entities to pass income, credits, and deductions through to shareholders.
In short, S corps don’t pay income taxes—the shareholders split the income or losses between each other and report everything on their personal tax returns. This eliminates double taxation, which is imposed on C corps.
Since S corporation is technically a tax status, you can’t incorporate this business structure from scratch. You need to start by forming a C corp and then apply for S corp status with the IRS.
S corps can only issue one class of stock and must have 100 or fewer shareholders. All shareholders in an S corporation must be US citizens or residents.
S Corporation Pros:
- Avoid double taxation
- Reduce self-employment tax
- Qualified business income deduction
- Easier to declare losses to offset income
S Corporation Cons:
- Harder to raise outside capital
- IRS can revoke your S Corp status if you’re trying to take advantage of the system
- Can only issue one class of stock
- Stricter requirements for owners
C corporations are the default business entity whenever you incorporate a business in the United States. Similar to LLCs, one of the main reasons people choose to form a corporation is limited liability. This gives owners of a C corp protection against creditors or anyone trying to sue the company—owners’ personal assets are shielded.
By default, C corps are taxed as separate entities. So, in addition to filing a personal tax return, your C corporation will also file a corporate tax return.
This means that your business income is essentially taxed twice, once on the corporate return and then again as dividends on your personal return.
Under the new Tax Cuts and Job Acts, C corps pay a flat corporate tax rate of 21%, which is often lower than many individual income tax rates. C corps also make it easier for you to issue multiple classes of stock without restrictions on shareholders.
C corps are ideal for growing businesses that want to look appealing to new investors and potentially be publicly traded in the future.
C Corporation Pros:
- Flat corporate tax rate of 21%
- Appealing to outside investors
- Easier to raise money
- No restrictions on the number of shareholders or their citizenship
- Ability to issue two classes of stock
C Corporation Cons:
- Double taxation
- No personal write-offs
- Need to file two separate tax returns (individual and corporate)
S-Corp vs. C-Corp Example
Let’s look at a hypothetical scenario that compares the taxes owed between an S corp and a C corp. In this scenario, we’ll say that Company ABC made $100,000 in a year.
As a C corporation, the business is subject to the 21% corporate income tax ($21,000). The remaining $79,000 could be distributed as dividends to the owners. The dividend tax rate for single filers is 15% on dividends of $40,401 to $445,850. So you’d pay $11,850 in dividend taxes for a total of $32,850.
With S corp status, the $100,000 would be passed through to your personal tax return, which is subject to a 24% tax rate for individual filers. The Tax Cuts and Jobs Act allows you to deduct 20% of your business income from your net income, putting your taxable income rate at 24%. In this scenario, you’d owe $19,200 in taxes (24% of $80,000).
To be clear, this is not tax advice. While the S corporation in this scenario paid fewer taxes, not all factors have been considered. The purpose of this example is to illustrate how two corporations making the same amount of money in a year can have very different tax implications based on whether it’s an S corp or C corp.
Quick Tips to Decide if an S-Corp or C-Corp is Better For Your Business
Whether you’re forming an S corp or a C corp, you’ll need to go through similar steps to legally create a business entity in your state. With the exception of filling out IRS Form 2533 for S corp tax status, the formation process for both entities is essentially identical.
Forming a corporation can be a bit intimidating, especially if you’ve never gone through this process before. Fortunately, online formation services like Incfile make this process much easier.
Incfile is one of the most reputable business formation services in existence. All you need to do is fill out some basic details about yourself and your corporation, and they’ll handle all of the paperwork and state filings on your behalf.
They offer unlimited name searches, EINs, corporate bylaws, banking resolutions, and free registered agent services for one year. If you want to apply for S Corporation status with the IRS, Incfile will handle Form 2553 for you as well.
Incfile’s base formation package is 100% free—you just need to pay the state filing fee.
Here are some quick tips to help you decide whether an S corp or C corp is right for your business.
Tip #1 — Take a Business Entity Quiz
Rather than going through the pros and cons of each entity type, you can take an online quiz to get started in the right direction.
Incfile has a formation quiz that takes just a minute or two to fill out. Upon completion, they’ll email you a suggestion of the entity structure that’s right for your business.
Some examples of the questions you’ll answer include:
- Are you or any of the other business owners a US citizen?
- Do you want the business to make a profit?
- Do you plan on selling shares of stock to a large group of people?
- Are you planning to file an IPO on a public stock exchange within 1-2 years?
- Do you want shareholders to be personally responsible for business debts?
- Will you pay yourself as an employee and owner of the business?
- Do you want the ability to easily transfer ownership of the business?
Don’t just blindly follow the suggested entity type based on your quiz results. You should still do your due diligence to ensure that option is right for you. But this type of resource is a great way to narrow your focus.
Tip #2 — Start With a C Corp
As previously mentioned, S corporations are technically a tax status, not an entity type. So when you’re first starting a corporation, your default entity type will be a C corp.
If you don’t want this decision to hold up your business formation process, just stick with a C corporation for now. You’ll have 75 days from the formation date to file for S election status.
Even after those 75 days pass, you can always file Form 2553 down the road. According to the IRS, you can file Form 2553 for S corp status:
- Within two months and 15 after the beginning of the tax year where the S election goes into effect, or
- At any time during the tax year preceding the S election going into effect
In short, you can basically file to become an S corporation months or years from now. While your tax status might not change immediately, it will go into effect the following tax year, at the latest.
It’s always in your best interest to start with a C corp and then switch to an S corp instead of trying to switch in the opposite direction. Let’s say you want to form an S corp, then change to a C corp five years later. This decision would have significant tax implications for your business.
You may need to pay corporate taxes on conversions from an S corp to a C corp. This means your business might owe corporate taxes from previous years.
So it’s better to start with a C corp if you’re unsure. It’s typically less expensive and easier if you change your mind down the road.
Tip #3 — Are You a Small Business?
Generally speaking, C corporations are designed for bigger businesses. If you’re running a small business and don’t plan to scale into a massive company, going with an S corp is probably a better option for you.
C corps offer multiple classes of stock, unlimited shareholders, and unlimited shares.
It’s rare for a small business to issue ownership to foreign investors in the form of corporate stock. That’s just not what small businesses do.
If you’re small right now but plan to scale into a bigger company in the coming years, then a C corporation might be a viable option for you. But if you fall into the stereotypical “small business” category, an S corporation will likely be a better fit for your needs.
Long-Term Strategies For S-Corps vs. C-Corps
Beyond the quick tips and best practices mentioned above, you need to consider some larger strategic items before deciding between an S corp or a C corp. These strategies may not impact your business today, but they’ll play a role in the future of your operation.
Strategy #1 — Avoiding Double Taxation
There are only two ways to avoid double taxation:
- S corporation status
- Operating at a loss
So if you don’t want your business subject to double taxation, then S corp status is the simple choice. But let’s take a moment to explore the second option.
C corps aren’t taxed twice if they don’t make a profit. While this might seem like an illogical way to do business, it’s a common strategy used for companies that want to scale.
You can reinvest all profits into the business instead of paying them out as a dividend.
Wages and salaries, including the owner’s salary, can usually be classified as deductible expenses. So your salary won’t be subject to corporate taxes. It’s worth noting that the IRS can always re-classify an excessive salary as a taxable dividend if you’re paying yourself too much in an effort to operate at a loss.
Strategy #2 — Issuing Stock to Investors
Both S corps and C corps can issue stock to investors. But the rules and limitations vary between the two.
If you want to grow with infinite investors and potentially file an IPO (initial public offering) on a public stock exchange, a C corp is the only way to do this.
S corps cannot have more than 100 shareholders. Those shareholders must be US citizens or residents of the US. This business structure isn’t always appealing, even to qualified investors, because of the long-term restrictions imposed.
Where do you see your company in three, five, or ten years? If you see yourself as a giant in your industry with public investors, then you need to go with a C corp. If you see yourself operating with a smaller group of owners with no interest in going public, an S corp should be fine for you.
Once you’ve determined whether an S corp or C corp is right for your business, it’s time to go through the official incorporation process.
You’ll need to file articles of incorporation with your state, obtain an EIN, create corporate bylaws, elect a board of directors, hold regular meetings, issue stock, and more. This is a complicated process if you’re doing it on your own.
Check out our guide of the best online legal services. In addition to legal forms and legal advice, most of these platforms also offer business formation services.