S-Corp Vs. C-Corp In 2023 – Which Is Best For Your Business?
Your choice of a legal business entity has a significant impact on many aspects of your business, ranging from financing, and taxation to general business growth. Given the overwhelming number of entities, it is always hard to choose the right one for your business. Ideally, it will require side by side comparison between two entities. Thankfully, we have taken the initiative to compare the two most confusing business structures: S-corp vs C-corp.
In essence, there is no size-fit-all answer as to which entity is the best for businesses. Every business entity has its pros and cons and the benefits will outweigh the drawbacks depending on your business needs. With that being said, choosing the right business entity starts by analyzing each business structure right from its formation, taxation, protection, advantages, and disadvantages among many other factors.
Whether you are standing out or your business is growing, our comparison will help you make an informed decision between C-corp vs S-corp.
S-Corp Vs C-Corp: Which Is Best For Your Business?
As mentioned before, there is never a size-fit answer as to which entity is the best for your business, it will all depend on your business needs.
We would recommend you file C-corporations if you want the best experience with a corporation. C-corps don’t have restrictions on ownership transfer, or the number of owners among others. If you are looking to avoid double taxation, however, you should file for S-corp. S-corp owners pay their personal income tax from their dividends and they are not subject to corporate tax.
S-Corp Vs C-Corp: Which One Should You Choose?
There is never a size fit answer as to which entity is the best for your business, It will all depend on your business needs. You should opt for S-corp when:
- If you want to save from taxation by avoiding double taxation
- You are not looking to sell shares to more than 100 people or a non-US investor
- Your corporation will be distributing dividends to shareholders
- You don’t plan on giving preferred stock
On the other hand, C-corp’s status is very open and doesn’t have the above-mentioned restrictions. You should opt for this entity when:
- If you don’t plan to make distributions to shareholders
- You want to obtain equity financing
- Seeking shareholders not allowed to be S-corp such as non-U.S. citizens or residents
- You want shares to be transferred freely
- You want to issue preferred stock
Differences Between S-Corp vs C-Corp
C-corp is considered the standard corporation and it is formed by filing articles of incorporation along with the necessary filing fees. Though the formation process varies with the state, the three most common steps are:
- Choosing your business name
- Choosing a registered agent
- Filing articles of incorporation with the secretary of state
On the other hand, S-corp is not a normal business entity but a tax election that an eligible corporation may choose. Therefore, there is nothing like forming an S-corp but you can convert your corporation to an S-corp by filing IRS form 2553.
While these two entities are both owned by shareholders, S-corp and C-corp differ in terms of ownership in various ways.
Each share of an S-corp common stock gives shareholders an equal ownership stake in the business. This is contrary to C-corporations where there is unequal ownership of stakes. For instance, one share of preferred stock may offer a greater ownership stake in the company or company dividend than one share of common stock.
- Shareholder restrictions:
Restrictions on ownership are one of the main differences between these two entities. Here is a summary of S-corp shareholders restrictions:
- Must be a domestic corporation
- Can only issue a single class of stock
- Cannot have more than 100 shareholders
- Can be an individual, estate, or some trust, but not other S-corps, LLCs, partnerships, corporations, and even some other trusts.
On the other hand, C-corporations have no restrictions on ownership. Anyone or other business entity can own a C-corporation and you can have an unlimited number and different classes of shareholders.
Even though the two corporations can issue stocks, S-corp only issues one class of stock while C-corporation issues different classes of stock. To be precise, S-corps can only issue common stock while C-corps issue both common and preferred stock.
The most popular difference between C-corporations and S-corporations is tax status. S-corp is treated as a pass-through entity for tax purposes. Meaning, that the corporation distributes company income and loses it to the individual shareholder as dividends. Each shareholder then reports their share of the business’s federal income and losses on their personal tax return.
Additionally, each owner of S-corporations can deduct 20% of qualified business income from their income tax as expressed by the Tax Cut and Jobs Act of 2017. However, the deduction is set to expire in 2025 unless Congress extends the law.
C-corp tax is subject to double taxation where the business profit is taxed at both corporate income and federal income.
Before the profits can be distributed among the owners, the corporations must pay corporate income tax at the corporate rate. The corporation then pays its shareholders dividends from after-tax profits as dividends. The shareholders then pay their federal tax from the dividends.
That makes the C-corp tax more costly compared to the S-corp tax and it is one of the reasons we would recommend S-corps for small businesses.
S-corps are considered pass-through entities for tax purposes and each shareholder only pays federal income tax. For that reason, S-corp accumulates a lot of capital from tax advantages.
However, S-corp limits its ability to accumulate capital from new investors by limiting the number of shareholders. Besides, it is very hard for S-corps to obtain equity financing due to the fact that they are restricted to U.S. citizens.
As long as you don’t keep an inventory, S-corps allows you to use either cash or an accrual accounting method. However, you will have to use accrual accounting if you maintain an inventory.
C-corporation must use accrual if the annual gross receipts for the last three years were more than $5, otherwise, they will use the cash method. However, tax shelters and general partnerships that have C-corps as partners but fail the $5 million test must also use the accrual method.
S-Corporation Vs C-Corporation: The Similarities
By default, C-corp is the standard corporation under IRS rules. S-corp however is a subchapter of a standard corporation that has elected special tax status with the IRS. That means that S-corp is a kind of substructure of C-corp, and so, they share a lot of similarities.
With that being said, here are some of the similarities between the two corporations.
Corporations are owned by shareholders or stockholders. The stockholders own shares in the company but do not have the right to participate actively in the management of the company. Instead, they are expected to choose the board of directors who actively participate in various business affairs.
Limited Liability Protection
The company owners are typically not liable for business debts and liabilities. That is to say, when a vendor sues your company, the company assets will be used to pay the losses while your assets remain intact.
As corporations, both S-corps and C-corps are legally separate entities from the owners. Put simply, this means that stockholders are not personally liable for the business’s debts or obligations. This is a major selling point of corporations.
Corporations have shareholders, officers, and directors. The stockholders own the corporation but it is the corporation that owns the business. The stockholders elect the board of directors to handle management and policy issues. The work of day-to-day running of the business is in the hands of the CEO, COO, and CTO among other officers of operation.
Separate Legal Entities
Corporations are regarded as separate legal entities with the ability to conduct business in their own names. As such, both S-corp and C-corp can own property, borrow money, enter into a business contract, pay tax, sue, and be sued.
Being a separate legal entity, most states may rule that the company continues operating even when a shareholder leaves or joins the business.
The registration of a corporation involves filing articles of incorporation/certificates of incorporation with the secretary of the state. This applies whether you choose to be taxed as an S-corp or C-corp. Once the corporation is formed, you can now choose to be taxed as S-corp during which you may have to fill out a few documents depending on the state.
Personal Income Taxes
Corporations distribute business income or profit among shareholders as dividends and this is treated as taxable income. The shareholders then report their income on their tax returns.
Advantages And Disadvantages Of S-Corp Vs C-Corp
- Single-layer taxation
S-corps are known to offer tax advantages over C-corps due to their single-layer taxation. In essence, S-corporation doesn’t pay corporate income tax. Instead, each shareholder reports the company’s share of income on their tax return.
- 20% qualified business income deduction
Up to 20% net deductions for the eligible S-corp shareholders given by the Tax Cuts and Jobs Act of 2017 is another tax advantage.
- Pass-through of losses
As mentioned before, S-corporations are treated as pass-through entities. Just as the company income, the company losses are pass-through to the company owners who can then use the losses to offset the income.
- Unlimited number of shareholders and ownership
C-corporations can be formed and owned without limitation on the number of shareholders. Besides, any individual, other types of corporations, LLCs, trusts, or estates from any part of the world are free to own C-corps.
- No restrictions on classes of stock
Unlike S-corps, C-corps can issue more than one class of stock, including common and preferred stock.
- More options for raising capital
Given that C-corporations do not impose the same restrictions you encounter within S-corps, it makes it easier to acquire equity financing.
- A limited number of shareholders
S-corps owners are only limited to 100 shareholders. This limitation in ownership results in limitations in several other aspects. For instance, the company’s ability to raise capital from new investors.
- Other shareholder restrictions
Shareholders must be individuals and US Citizens or residents. That makes it harder for S-corps to obtain equity financing as venture capital.
- Preferred stock is not allowed
For investors who want multiple classes of stocks, this is not your entity. S-corm only issues common stock, meaning the preferred stock is not allowed.
- Transfer Restrictions
To make sure they don’t end up with ineligible shareholders, most S-corps restrict their shareholders’ ability to transfer or sell their shares. Ineligible shareholders may make the IRS terminate its S-corp status.
- Double taxation
C-corps pay income taxes on their earnings and the owners again pay taxes on dividends. That means C-corp shareholders report to the corporate tax return and federal tax returns resulting in double taxation.
How To Become An S-Corporation?
To become an S-corp, you first need to become a standard corporation by filing the articles of incorporation with the secretary of the state. After that, you will have to file form 2553 with the IRS in order to have your corporation taxed as S-corp.
However, you will have to meet some specific internal revenue code (IRC) requirements including, it has to be a domestic corporation, having not more than 100 shareholders, and having only one class of stock, among others.
Besides, for your election to be considered effective in the current tax year, the IRS requires that form 2553 be completed and field:
- Anytime prior to the 16th day of the third month (should happen by the 15th of the match)
- Anytime during the preceding tax year.
How To Become A C-Corporation?
A C-corp is the standard corporation and once you form a corporation, you have become a C-corp. The corporation is formed by filing articles of incorporation or certificates of incorporation with the state filing fees.
It starts by choosing a business name and doing a thorough name search to ensure it is available to you. After which, you should choose your corporate registered agent. All these have to be included in the articles of incorporation. Depending on the state requirement and your decision, other activities may follow afterward.
Our S-corp vs C-corp discussion will be enough to help you make an informed decision. From our discussion, we agreed that a C-corporation is the standard corporation while an S-corporation is a corporation tax selection. That is to say, you may only opt for S-corps when you want some tax benefits, such as avoiding the standard corporation double taxation.
Due to S-corporation tax benefits, it is more popular with small businesses since they are likely to save a lot from taxes. C-corporation on the other hand offers a lot of freedom and it is popular among large and small business owners alike.
Frequently Asked Questions (FAQs)
You can easily convert from an S-corp to a C-corp by revoking the S-corp election voluntarily, or the IRS can terminate it for you. On the other hand, you need to complete IRS form 2553 if you qualify to convert from C-corp to S-corp.
Limited liability company members are treated as self-employed for tax purposes. To avoid being subjected to self-employment taxes, you may elect to be taxed as any type of corporation. However, the best idea is to elect S-corporation status because you will only have to worry about single-income tax rates and no double taxation.
Another great corporation option that will work even better is a limited liability company. LLCs offer you liability protection of corporations without the limitations of the S-corp and still offer you an opportunity to elect to be taxed as an S-corp.
You should choose an S-corp for tax benefits. S-corps are not taxed twice like C-corps. The company owners pay personal income tax from the company dividends only and that may make you save a lot from taxes
LLC is a special entity type with tax flexibility of sole proprietorships and partnerships as well as protection capabilities of corporations. For instance, it is treated as a self-employment entity for tax purposes just like sole proprietorship or partnership. However, you can elect to be taxed as a C-corp or an S-corp to avoid being taxed as self-employed.
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- Sba.gov. (2023). Choose a business structure | U.S. Small Business Administration. [online] Available at: https://www.sba.gov/business-guide/launch-your-business/choose-business-structure.
- Instructions for Form 2553. (n.d.). Available at: https://www.irs.gov/pub/irs-pdf/i2553.pdf.