Understanding the distinctions between a S corporation and a C corporation may save you money, time, and problems.
When creating a company, both C corporation and S corporation classifications are acceptable. While they share certain characteristics, they also have significant distinctions.
Make sure you understand the benefits and drawbacks of each option before making a selection.
The Fundamentals of Business
C companies and S corporations have many characteristics. Shareholders are the owners of a company, and they elect directors to supervise corporate operations. The directors appoint executives to oversee day-to-day operations. Profits, known as dividends, are given to shareholders in proportion to the number of shares they possess.
A corporation is founded by drafting articles of incorporation and submitting registration paperwork to the state.
Corporations must issue stock, create bylaws, have annual director and shareholder meetings, maintain meeting minutes, issue written corporate resolutions for major decisions, submit yearly reports with the state government, and pay annual fees. Failure to do so may result in the loss of personal liability protection as well as the dissolution of the company.
The formation of a company limits the owners’ personal liabilities. A company is formed under state law and is legally distinct from its owners. Only the corporation’s assets are liable to corporate obligations since it is a distinct legal entity. With a few exceptions, a shareholder is not personally accountable for company debts, and the shareholder’s assets are safeguarded from business creditors.
While C companies and S corporations have certain commonalities, they also have some significant distinctions.
Every firm begins as a C corporation. By submitting IRS Form 2553, Election by a Small Business Corporation, with the Internal Revenue Service, a C corporation may be changed to a S corporation (IRS). There may also be state paperwork to complete in order to gain S corporation status for state tax reasons.
It is known as a “S” company because the legal rules that allow it are located in Subchapter S of Chapter 1 of the Internal Revenue Code.
For companies operating on a calendar year basis, Form 2553 must be submitted no later than March 15 of that year to achieve S corp status for that year. It must be submitted no later than the 15th day of the third month of the fiscal year for firms operating on an alternate fiscal year. It may, of course, be submitted at any moment during the prior tax year.
The primary motivation for forming a S corporation is to save money on taxes. There is a significant difference in how a C corporation and a S corporation are taxed.
C company earnings are taxed and reported on the corporation tax return for federal tax reasons. Any after-tax gains issued as dividends to shareholders are taxed again and must be disclosed by the shareholders on their personal tax filings.
By adopting S corp classification for your company, you may avoid “double taxes.” An S corporation is regarded in the same way as a single proprietorship or a partnership. Profits (or losses) are distributed to shareholders through the S corp. and are only taxed and reported on the owners’ personal tax returns.
Many states also transfer income and losses on to S company shareholders. However, a few states double tax S corporations.
A C corporation will provide you additional options when it comes to selling stock. According to the IRS, a company that chooses S corporation status may not:
Have over 100 stockholders
Make more than one kind of goods available.
Have stockholders who are neither citizens or residents of the United States
Be owned by a C corporation, another S corporation, an LLC, a partnership, or a variety of trusts.
None of these limitations apply to C companies, which may aid in the company’s growth. Having more than one class of stock, for example, might let a company acquire funds from investors without granting them voting rights.
A corporation may choose to give certain benefits, such as health, life, and disability insurance, to shareholders who are also workers. The cost of such benefits may be deducted by the company and are not taxable to the shareholder in the case of a C corporation, as long as the benefit is offered to at least seventy percent of the workers.
Benefits cannot be deducted by a S corporation, and they become taxable to shareholders who possess more than 2% of the shares.
Which Is the Best Option for You?
Small enterprises, in general, prefer S corp. status since they generally fall inside the legal constraints for a S corp. Certain sorts of businesses benefit more from being organised as a C company.
Large firms, those with a lot of start-up cash and a lot of ambition, or those aiming to sell shares abroad are frequently not eligible for a S corp. Large businesses may choose the flexibility of having more than 100 shareholders, selling shares to non-U.S. citizens or resident aliens, having shares controlled by other organisations (corporations, LLCs, partnerships, trusts, and so on), or issuing more than one class of stock.
In general, a S corp is more popular with smaller firms because to the potential tax benefits, but a C corp is more popular with bigger organisations due to the greater freedom to obtain capital. However, whether a C corporation or a S corporation is ideal for your firm is based on a comprehensive examination of numerous aspects as they pertain to your specific scenario.