If you structure your business as a corporation, you’ll face an important decision: whether to set up an S corp or a C corp. This choice has big implications for how much you’ll pay in taxes, your ability to raise money and how easily you can expand your business.
An S corp, or S corporation, is a pass-through entity that reports its profits on the owners' personal taxes. S Corp ownership is restricted to up to 100 shareholders. A C corp, or C corporation, is subject to corporate tax rates and has no restrictions on ownership.
This guide explains the differences between these business entity types, along with the pros and cons of each, so you can decide which is right for your business.
S corp vs. C corp: Quick guide
| S corp | C corp | |
|---|---|---|
| Formation | Elect by filing IRS Form 2553. | Default type of corporation. |
| Taxes | Personal income tax on profits (pass-through taxation). | Corporate tax plus personal income tax on dividends. |
| Raising Capital | Harder to raise venture capital. | Better for raising venture capital. |
| Number of Shareholders and Stock Classes | 100 or fewer shareholders, one class of stock. | Unlimited shareholders, multiple classes of stock. |
| Type of Shareholders | Shareholders must be U.S. citizens or residents. | U.S.-based and foreign shareholders okay. |
What are the differences between an S corp and a C corp?
The key differences between S corporations and C corporations relate to formation, taxation and ownership.
Generally, taxes are the biggest and most important difference between the two. C corps are subject to corporate tax rates. S corps allow for pass-through taxation. This means owners report the business profits and losses on their personal income tax returns.
Formation
The most basic difference between S corporations and C corporations is formation. Whether you structure your company as an S corp or C corp, you'll need to follow three steps:
- Appoint a registered agent.
- Create corporate bylaws.
S corp formation
To structure your company as an S corp for federal tax purposes, file IRS Form 2553 . You may have to file additional forms at the state level to be treated as an S corp for state taxes.
C corp formation
The C corp is the default type of corporation. When you file articles of incorporation with your secretary of state, your company will become a standard C corp.
For more information, check out our step-by-step guide on how to incorporate.
Taxation
Taxation is the biggest difference when comparing an S corp and a C corp. Many business owners structure their companies as S corps to save money on taxes.
C corps are subject to “double taxation.” First, the C corp pays taxes on its profits when it files its corporate income tax return. Then, the C corp owners may pay taxes on those profits if the corporation distributes the profits to shareholders in the form of dividends. This second tax will show up on the owner’s personal income tax return.
There are some ways to avoid double taxation as a C corp, including:
- Make no profits (operate at a loss).
- Reinvest profits back into the business instead of paying dividends.
Wages and salaries, including owner salaries, are generally tax-deductible expenses. However, the IRS can "re-label" excessive salaries as taxable dividends.
S corp taxation
An S corp is a pass-through entity for tax purposes. This means shareholders report their share of the business’s income and losses on their personal tax returns. Owners pay taxes at their personal income tax rate.
Additionally, owners of S corporations may be able to deduct up to 20% of qualified business income (QBI) from their personal tax returns. Businesses in specific service trades or professions may face limits on the deduction at high income levels.
Be sure to consult a qualified lawyer or tax pro to determine how an S corp could affect your taxes.
S corp vs. C corp tax example
Here’s a simplified example to illustrate the tax differences between the two corporation types.
| S corp | C corp | |
|---|---|---|
| Assumed tax rates | 22% individual rate | 21% corporate rate 15% qualified dividend rate |
| Business profit | $100,000 | $100,000 |
| Business tax | $0 | -$21,000 |
| QBI discount | -$20,000 (tax-free) | Not applicable. |
| Owner tax | -$17,600 (22% of $80K) | -$11,850 (15% of $79K) |
| Total cash you keep | $82,400 | $67,150 |
An S corp may save owners money on taxes, though that isn't always the case. Certain types of business-level tax deductions, such as charitable donations and fringe benefits, are fully deductible only for a C corporation. A qualified accountant or business attorney can help you figure out the structure friendliest to your bottom line.
Ownership
The last major difference between these corporate structures is the ownership restriction. C corporations are more flexible if you’re looking to expand or sell your business.
C corp ownership
C corporations have no restrictions on ownership. You can have an unlimited number of shareholders, as well as different classes of shareholders.
Venture capital firms and angel investors like to hold preferred stock, which is only an option for C corps. This makes it much more difficult to fundraise as an S corp.
Additionally, if you plan to sell your business or spin-off a subsidiary, a C corp could be a better choice. Other corporations, LLCs or trusts can own C corps, which is not true of S corps.
S corp ownership
S corporations can have only up to 100 shareholders. Shareholders of an S corp must be United States citizens or resident aliens. C corps, on the other hand, are open to foreign investors.
S corporations are limited to one class of stock, meaning that there’s only one kind of shareholder. With no hierarchy or difference between shareholders, fundraising becomes harder.
What are the similarities between S corps and C corps?
S corps and C corps are similar in several ways:
- Limited liability protection: Both S corps and C corps are legally separate from their owners, so their shareholders have limited liability protection. This means shareholders are not personally liable for the business's debts or obligations. This is a major selling point of a corporation.
- Incorporation: You'll need to complete the proper incorporation documents, file articles of incorporation, appoint a registered agent and create corporate bylaws.
- Structure: Although the shareholders of an S corporation or C corporation own the business, they don’t make most of the decisions. Management and policy issues are left to the company’s shareholder-elected board of directors. The day-to-day work of running the business is on the officers of the corporation, like the CEO, COO and CTO.
- Compliance: Both S corps and C corps have to meet certain documentation and compliance obligations. These may include issuing stock, paying fees and holding shareholder and director meetings.
S corp vs. C corp: How to decide
Many small-business owners opt for S corp status to save money on taxes. But if you're planning to raise investor money in the future or have plans to grow into a very large company, a C corp may be the better option.
Here's a side-by-side look at the advantages and disadvantages of S corporations and C corporations.
| S corp | C corp | |
|---|---|---|
| Advantages |
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| Disadvantages |
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If you're unsure of what's best for your business — and what the further implications of any entity type might entail — it may be useful to consult a business attorney or online legal service to help you make the right decision.
