S Corporation vs C Corporation
Always seek out information pertaining to your jurisdiction before you make a decision.
Notable similarities between S Corp and C Corp
- Both are corporations and must adhere to state and federal law concerning corporations. All corporations are required to follow the internal and external corporate formalities and obligations, such as adopting bylaws, issuing stock, maintaining a registered agent and registered office, holding shareholder and director meetings, filing annual reports, and paying annual fees.
- Both are legal entities that exist separately from the owners.
- Both offer limited liability for their shareholders.
- Both are created by a state filing. You have to file Articles of Incorporation (or Certificate of Incorporation) regardless of whether you want the corporation to be taxed as a C corporation or S corporation.
- Both have shareholders, directors and officers. The shareholders own the corporation, and the corporation owns the business. The board of directors is elected by the shareholders. The board of directors elects the officers that manage day-to-day operations for the business.
Important differences between C Corp and S Corp
Taxation of a C corporation
A C corporation is a separately taxable entity that files its corporate tax return on IRS Form 1120. The C corporation pays taxes at the corporate level.
Dividends distributed to shareholders are personal taxable income for the shareholder.
Taxation of an S corporation
An S corporation is a pass-through taxation entity. In this regard, it is similar to a sole proprietorship or partnership. The S corporation files its tax return on IRS Form 1120S, but no income tax is paid at the corporate level. Instead, profits and losses pertaining to the business are passed through to the shareholders. Each shareholder reports this on their own tax return, and any tax due is paid at the individual level.
The Internal Revenue Code contains shareholder restrictions that must be adhered to if a corporation wants to be taxed as an S corporation.
- An S corporation is not allowed to have more than 100 shareholders.Spouses (and their estates) are considered one, not two, shareholders. Families, defined as individuals descended from a common ancestor, plus spouses and former spouses of either the common ancestor or anyone lineally descended from that person, are considered a single shareholder as long as any family member elects such treatment.
- The shareholder in an S corporation must be an individual unless it falls under one of the exceptions that permits certain types of trusts, certain types of estates and certain types of tax-exempt corporations to be shareholders in an S corporation. C corporations can not own shares in an S corporation.
- Shareholders are not allowed to be non-resident aliens. A shareholder must be a U.S. resident or U.S. citizen (or both).
- An S corporation can not have more than one class of stock. Preferred stock is not allowed.
These restrictions are not applicable to C corporations, and that is a major difference that needs to be taken into account.
To avoid accidentally losing their S corp status, most S corps restrict their shareholders’ ability to sell or transfer their shares. This is because it only takes one ineligible shareholder to make the corporation revert back to being a C corporation.
Why elect to be an S corp?
Here are some reasons why the S corp can be an appealing alternative to the C corp.
- Single-layer taxation, since the S corp does not pay corporate-level income tax.
- Both profits and losses are passed through to the shareholder level, so you can (with certain limitations) use a loss to offset other income.
- The Tax Cuts and Jobs Act of 2017 permits eligible S corp shareholders to deduct up to 20% of net qualified business income.
How to form a C or S corporation
The first step is to form a corporation. The standard corporation is the C corporation. If the corporation wants to turn into an S corporation, it files Form 2553 with the IRS to let them know that it fulfills the requirements for being an S corporation and wants to be taxed under Subchapter S. Some states also require the filing of a state-level S corporation election after incorporation.
How to form a corporation
You form a corporation by filing a document that (in most states) is called Articles of Incorporation. In most states, you file it with the Secretary of State. Examples of information that must be included are corporation name and the corporation’s registered agent. You will be required to pay a filing fee.
After the incorporation process is finished, the corporation needs to fulfill certain other steps, such as adopting bylaws, holding a meeting for directors and shareholders, and issuing shares of stock.