S Corp vs. C Corp: Differences in Setup and Taxes

Did you know that new business applications in the United States have been higher than ever since the start of the COVID-19 pandemic? Numbers of monthly applications have stayed consistently above 300,000 since the spring of 2020!

One of the first major decisions a new business owner has to make is deciding what kind of business structure they want to use. Sole proprietorship, corporation, LLC…there are so many options!

Many business owners don’t realize that even when you decide to give your business corporation status, you have to choose between S Corp vs C Corp. And the difference between these two kinds of corporations matters more than you might think!

If you’re starting to get overwhelmed by the choices available to you, don’t panic. Here, we break down the exact differences between C Corps and S Corps and how your business classification figures into your strategic tax planning.

What is an S Corporation?

No matter what type of corporation you use, they both offer your owners limited liability protection. This means that, unlike a sole proprietorship, owners do not take personal responsibility for business debts.

After filing your articles of incorporation, you’ll need to fill out Form 2553 to indicate that you want your business to be an S Corp. Otherwise, it’ll automatically be filed as a C Corp (more on this type of business below). Additional requirements for filing an S Corp can vary from state to state.

S Corps can only have up to 100 owners. All owners or shareholders must also be citizens or residents of the United States. Because of these two shareholder requirements, S Corps tend to restrict how owners can sell their shares.

Additionally, other business entities cannot become owners of the company. This means that the company must remain private, which can limit the ways in which you can raise investment capital.

All these limitations on ownership may seem restrictive, but they also provide S Corps with some advantages. Limited ownership means that each shareholder has a greater opportunity to influence day-to-day business operations and strategic decisions. There is also no hierarchy to the kind of shares sold through an S Corp, so all owners hold the same amount of power over the business.

S Corporation Taxes

S Corporations have several tax advantages over other business types.

S Corps are not subject to corporate tax law, so the business itself does not pay any taxes. Instead, all owners split the profits and report that income on their personal income taxes. This is why S Corps have to file Form 2553 at the time of incorporation, as this form creates the link between the personal tax returns of the owners and the business.

Because all income is reported on personal tax returns, the owners can deduct a portion of their business income on their personal taxes. They may also write off their portion of any business losses incurred.

Because these businesses don’t pay corporate tax, the IRS may look at S Corp returns more closely than C Corps. You’ll need to be extra cautious to make sure you’re filing your returns correctly and not making any bookkeeping mistakes.

Additionally, any potential deductions go on your individual owners’ tax returns. This means that some things that might be deductible for a C Corp (such as employee benefits) may not be deductible for an S Corp.

What is a C Corporation?

When you file a business as a corporation, it is automatically designated as a C Corp. After filing your articles of incorporation, no further action is required from you.

Just like an S Corp, this type of corporation offers limited liability to shareholders. Unlike an S Corp, though, there are no ownership limitations or restrictions for C Corps.

This makes C corps more appealing to potential investors, as there’s no limitation to the number of owners the business can have. This also makes selling stock and acquiring funding easier for a C Corp than an S Corp.

C Corps can eventually be acquired by other businesses, making this a great move for any company interested in scaling in the future.

Another difference between C Corps and S Corps is that C Corps differentiate between two kinds of stock. They are known as common stocks and preferred stocks. There is a hierarchy between these two kinds of stocks, meaning that certain owners will hold more power over business decisions than other shareholders.

C Corporation Taxes

The biggest tax disadvantage to a C Corp is that it’s a taxable entity separate from any individual owners or shareholders.

Since the business is subject to corporate tax, it means that the business income is taxed twice, which is known as double taxation. Taxes are taken out on the corporate level, and shareholders are also responsible for paying taxes on any dividends they receive from the business.

This isn’t a huge deal for large companies, but for small companies, the extra taxation can make the difference between breaking even and suffering a loss as a business. You also can’t take any write-offs on your personal tax return as an owner. If you have a small profit margin, this may not be the best course of action for you.

Thankfully, keeping your business as a C Corp does offer some tax advantages. Charitable contributions from the business count as deductions, and you can claim up to ten percent of the business’s total income in this regard. Some employee benefits can also be written off on the corporate tax return.

S Corp Vs C Corp: Learn More Today

Now you know the main differences between S Corp vs C Corp business classifications. Which is best for you?

With a small business, it might make sense to take the extra steps to turn your business into an S Corp. For a larger business, or if you want more flexibility in shareholder options, C Corp might be a better fit. Either way, consulting with a professional is the best route to making sure you make the right choice for you, your stakeholders, and your corporation.

Interested in finding out whether you could be saving more on your business’s tax returns? Schedule a free consultation with us today to learn more!