December 7, 2022
A brief overview of the differences between an S corporation (S Corp) and a C corporation (C Corp), including the advantages and disadvantages.
Selecting the type of for-profit corporation you form and maintain involves organizational, tax, and fundraising strategy considerations. This post is a brief overview of the differences between an S corporation (S Corp) and a C corporation (C Corp), including the advantages and disadvantages. S Corp and C Corp designations refer to tax elections usually made with the help of your tax advisor. This article is intended for educational purposes only; please consult your tax advisor before making the decision to pick an election.
What are the similarities between S Corps and C Corps? Both S corps and C corps provide liability protection with respect to shareholders, as well as officers and directors. Most states have no preference with respect to which type of entity a company chooses and most do not require you to distinguish the difference upon formation. In addition, both corporate structures have ownership in the form of shares, management in the form of officers and oversight in the form of directors.
What are the differences between S Corps and C Corps? An important distinction between an S Corp and C Corp is in how the entities are treated for tax purposes. C corps are subject to “double taxation”, meaning the corporation itself pays income tax as well as shareholders when they receive distributions. In other words, the income is taxed at both the corporate level and the individual shareholder level. S corps, on the other hand, are pass through entities, like most limited liability companies. This means only the individual shareholder is taxed, not the corporation itself. A few factors should be considered when deciding which structure is right for you.
There are certain restrictions on S Corps that should be kept in mind when deciding to make that election. The three main restrictions are the following: (1) S corps limit the number of allowable shareholders in your company to 100; (2) your company’s stock cannot be owned by any other corporate entities; and (3) you can only have one class of issued stock. For example, your entity cannot issue both common and preferred stock, which may limit who will invest in your company. It is common for VCs to request that an S Corp be switched to a C Corp prior to investment because VCs typically take preferred stock in exchange for their investment.
What are the advantages of S Corps? With S Corps, you only have a single layer of tax and can have a twenty percent qualified business income deduction, which is advantageous for your entity. In addition, most founders use the S Corp election simultaneously with paying themselves a salary, which often results in lower personal income tax being paid by the founder.
What are the advantages and disadvantages of C Corps? C Corps can have unlimited shareholders without many restrictions. C Corps may issue multiple classes of stock, which provides more options for raising money. As stated previously, the biggest disadvantage to C Corps is double taxation.
To elect to be treated as an S Corp, an entity must file a Form 2553 with the IRS no more than 2 months and 15 days after the beginning of the tax year the election is to take effect. If the S Corp election is not made, the C Corp designation is the default.
If you have any questions about S Corps and C Corps, including which might be right for you, please contact us at info@afissio.com.
