Table of Contents
S corporations and C corporations (often called S corps and C corps) are both types of corporations, but they fall under different tax code subchapters. The requirements for each are outlined by the IRS in relation to taxation, and corporations must obey federal law. However, each state has its own separate set of incorporation rules.
How do you know which one to choose for your business? Find out what separates S corps from C corps in terms of taxes, ownership, and stock structure.
Key Points
• C corps can have an unlimited number of shareholders but are subject to double taxation.
• S corps can take advantage of pass-through income, but are limited to no more than 100 shareholders.
• C corps can offer multiple types of stock to shareholders, while S corps are limited to one type.
• S corps are by definition private companies, and if they wish to go public, they must convert to a different structure.
What Is a C Corporation?
A C corporation is a type of business entity that is the default taxation for any corporation under Subchapter C of the IRS tax code. Unlike a sole proprietorship, a C corporation acts as its own entity separate from the personal liability of the owners. Its capabilities include:
• Owning property
• Entering into contracts
• Managing money
• Becoming involved in lawsuits
C corporations also have certain responsibilities, including filing annual reports and paying taxes. The owners are considered shareholders, and they may be different from the people who actually operate the business. This structure offers liability protection to shareholders, who aren’t liable for any debts accrued by the company.
What Is an S Corporation?
An S corporation is another option for a company’s tax designation and falls under Subchapter S of the tax code. A major difference between an S corp vs. a C corp is that an S corp is considered a pass-through entity. That means that it allows shareholders to distribute profits (or losses) and file that income on their individual taxes rather than on the corporation’s tax returns.
This structure helps companies avoid the double taxation that C corporations often experience, which taxes both the company and the owners. However, S corporation owners are required to take a salary that aligns with market rates.
S corps are limited to domestic corporations and come with several other requirements that we’ll discuss below.
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Key Differences Between an S Corp and a C Corp
What is the difference between a C corp vs. an S corp? The three main areas to look at are taxation, ownership, and stock structure.
Taxation
Taxation varies widely between these two types of corporations, with C corps having a more stringent tax policy.
C corporations may be subject to double taxation if shareholders earn dividends or distributions. Here’s what that means: First, the C corp pays corporate taxes using IRS Form 1120. But shareholders must also file and pay their individual income tax on any dividends they receive each year. So profits are reduced by the corporate tax and shareholder owners must pay personal income tax on what they receive as well.
By contrast, S corporations operate as pass-through entities, which means corporate taxation is treated differently. S corps are required to file business taxes using IRS Form 1120S, but their profits aren’t taxed. Instead, the owners pay individual taxes on their salaries and any distributions taken from the S corp. Self-employment taxes do not apply to distributions.
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Ownership and Stock Structure
When looking at S corporation vs. C corporation ownership and stock structures, you’ll find more options available with a C corp.
Ownership
For starters, a C corporation (vs. an S corporation) can have as many shareholders (who are the company owners) as they would like. International shareholders are also allowed.
An S corp, on the other hand, can have no more than 100 owners. Additionally, S corp owners must be individuals or certain types of trusts and estates. Partnerships, other corporations, and nonresident aliens cannot be S corp owners.
Another differentiator is that S corp owners must be paid a W-2 salary and report it on IRS Form 1040 along with their distribution income.
Stock Structure
S corps are only allowed to have one class of stock, whereas C corps have more options available. The first type is common stock, which is usually reserved for founders and early employees. As the company grows, a C corp can offer preferred stock to investors. Each share class can be assigned different voting rights and dividend payments. C corps can eventually be publicly traded, while S corps must remain private with no more than 100 shareholders.
Pros and Cons of a C Corp vs S Corp
Both types of tax designations come with benefits and drawbacks.
| Pros | Cons | |
|---|---|---|
| C Corporation |
• Number of allowable shareholders is unlimited • Can sell shares to raise investment funds • Can choose between two types of stock classes |
• Double taxation due to income tax paid on profits and shareholder dividends • Must meet strict record-keeping regulations |
| S Corporation |
• Business profits pass through to owners’ individual taxes to avoid double taxation • Distributions are not subject to self-employment taxes |
• Limited to 100 shareholders and cannot go public • Owners must take a salary, which is taxed |
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When to Choose a C Corporation vs S Corporation
Size matters when choosing between these two tax designations. An S corporation may be useful for smaller businesses that want to reduce taxable income by taking distributions instead of paying corporate tax on profits. Owners must take salaries, so it’s better for entrepreneurs who intend to stay working in the business.
A C corporation vs. an S corporation is more complex, but gives you the opportunity to raise money and expand your shareholder base. Instead of relying on financing like a startup business loan or business line of credit, you can sell shares to raise funds and eventually IPO. You can also issue different types of stock to attract early talent for hiring purposes, then expand into preferred stock for investors.
The Takeaway
There are major differences to consider when choosing between a C vs. S corporation, especially when you’re looking ahead to consider future growth. Compare where you are today in your business with where you want to go (and how quickly) to pick the tax designation that makes the most sense for your company today and tomorrow.
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FAQ
What is double taxation and how does it affect C corp owners?
Double taxation refers to the two layers of tax experienced by C corps. The first is a corporate tax on company profits, and the second is personal income tax on shareholder dividends.
Can an S corp convert to a C corp?
Yes, an S corp can convert to a C corp by revoking its S corp status with the IRS. It must submit a written statement with signatures from at least 50% of shareholders.
Can a C corp have an unlimited number of shareholders?
Yes, C corps are allowed to have an unlimited number of shareholders, unlike S corps, which can have only 100.
What are the IRS eligibility requirements for an S corp?
The IRS requires an S corp to be in the U.S. with no more than 100 shareholders. There’s only one type of stock allowed, and shareholders must be individuals or a specific type of trust or estate.
Can an S corp issue preferred stock?
No, an S corp may only have one class of stock, so it cannot offer preferred stock to certain shareholders.
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