Compare C corp and S corp tax designations and which is right for you.
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As you embark on the adventure of forming a new business, you’ll learn that there are a number of business entities to choose from. Depending on your business’s needs, you might consider forming a corporation, limited liability company (LLC), partnership, or sole proprietorship. As you explore these options, you may find yourself considering the merits of an S vs. C corp and wondering about the difference between the two.
C corporations and S corporations are different tax designations available to corporations. Each has its pros and cons, and the best choice for you will depend on the circumstances of your individual business. Here, we provide an overview of what is an S corp vs. C corp to get you started. However, if you have additional questions about which is right for you, consider consulting a lawyer or tax professional.
When you’re ready to set up your C corp or S corp, we’re here for you with our Corporate Formation Services. Whatever your needs, our suite of business services can help you Start a Business and keep it running with Worry-Free Compliance.
The first thing most people think of when examining the benefits of an S corp vs. C corp is tax advantages. When you form a corporation, it will be taxed as a C corporation by default. This means it will be subject to corporate double taxation. With double taxation, the corporation is taxed first at the company level and then again on the personal income tax returns of its shareholders. Not sure what a c corp is? Review the c corp definition.
An S corporation, on the other hand, is a pass-through entity. This means the corporation’s income passes through to the individual shareholders and is taxed only on their personal tax return. To designate your corporation as an S corp, you must file Form 2553 with the Internal Revenue Service (IRS).
Apart from tax considerations, however, there are a number of pros and cons of an S corp vs. C corp to keep in mind.
Even though C corps are subject to double taxation, they have several advantages over S corps:
Depending on your goals as a business owner and the size of your business, you may find that these advantages outweigh the tax benefits of an S corp.
If you have big plans for the future growth of your business and want to keep your options open, a C corp might be the right choice for you. C corps offer the most flexibility when it comes to options for raising capital, paying shareholders, and growing your business.
Businesses that intend to reinvest their profits rather than distribute them as dividends may also benefit from C corp status. This avoids double taxation because the profits are taxed only at the corporate level and not on the business owners’ individual income taxes. If owners are in a high tax bracket, this may be particularly advantageous.
For many businesses, S corps offer a number of advantages over C corps, including:
Remember that an S corp is a tax election rather than a separate corporate entity. You can elect S corporation status whether you have a corporation or an LLC. However, it’s important to keep in mind that not all businesses have the option of filing as an S corp.
To take S corporation status, your business must meet specific requirements:
If your business doesn’t meet these requirements, the IRS will terminate your S corp election and your corporation will automatically revert to a C corp.
Also keep in mind that S corp status is primarily a federal tax election. Although many states allow you to take S corp status for state tax purposes, others don’t provide that option. In those states, your corporation may be subject to double taxation when it comes to state taxes even though you will enjoy pass-through taxation on your federal taxes.
Small or new businesses may benefit the most from filing as an S corp. This is especially so if they anticipate having losses at the outset, because owners can claim the losses as a deduction on their individual taxes, reducing their overall tax burden. This isn’t possible for C corps. You may also consider an S corp if you plan to work for the business and draw a salary, because filing as an S corp will save you money on your self-employment taxes.
Although there are some important differences between S corporations and C corporations, there are also many similarities. Both types of corporations:
The major distinctions between the two arise in the form of tax advantages and shareholder limitations.
If you have a small business, you may feel that the corporate formalities of either an S corp or a C corp are more than you want to deal with. Assessing the advantages of a C corp vs. S corp for a startup can be particularly challenging because you have so many other decisions on your plate.
However, it’s important to Compare Business Structures as you’re forming a new business. Choosing the right business structure can save you a lot of money in the long run, either by reducing your taxable income or protecting your personal assets through liability protection. The entity you choose can also affect your ability to raise capital and grow your business.
The best type of business structure depends on the individual circumstances of your business. If you’re uncertain about the best entity for you, a tax professional or attorney may be able to give you advice tailored to your individual circumstances.
If you’re considering an S corp, review our information about how to Calculate Your S corp Taxes to help you determine whether electing S corp status makes sense for you. As we mentioned above, an S corporation is a good choice for many small businesses, especially when they’re just starting out. As your business grows, you can change your tax election from S corp to C corp if you find yourself needing the additional flexibility of a C corp.
If you decide a C corp is best for you, you’ll need to take the following steps to form your business entity:
We can help you through this process with our C corp Formation Services.
The process of forming an S corp follows generally the same pattern as forming a C corp if your S corp is a corporation. If your business is an LLC, the process will vary slightly. For example, you’ll file different formation documents with your state, and you’ll establish an operating agreement rather than corporate bylaws.
But regardless of whether your business is a corporation or LLC, the final step to establishing your business as an S corp will be to file Form 2553 to let the IRS know of your election. Our experts can help you through the process of starting a business and creating an S corp.
To elect S corp status, you need to file Form 2553. If your business is an LLC, you first need to file Form 8832 and elect to be taxed as a corporation.
To change how your corporation is taxed, you need to notify the IRS. If you want to change your default tax status to S corp status, file Form 2553. If you want to stop being taxed as an S corp, you need to submit a statement of revocation to the IRS with shareholder signatures representing 50% of the corporation’s shares.
An S corporation can hold stock in a C corporation, but it can’t own more than 80% of the stock. C corporations can’t be shareholders of S corporations.
A non-profit is neither a C Corp nor an S corp. Rather, it’s classified as a 501(c) entity under the Internal Revenue Code.
Healthcare benefits are taxed differently for C corps and S corps. Typically, S corps can deduct the cost of healthcare benefits for employees. However, shareholders owning more than 2% of stock in the S corp must include insurance costs paid by the company for them or their family members as income. C corps, on the other hand, can deduct the cost of health insurance paid for both employees and owners.
A corporation must typically indicate that it’s a corporation in its business name, using a designation such as “Co.,” “Corp.,” or “Inc.” However, it doesn’t need to indicate whether it’s an S corp or a C corp. That designation shows up only on the company’s tax forms.
Whether you’re just starting out or have an established business, our slate of business services is here for you. When you’re ready to form your business entity, we can help you get your business up and running in no time with our business formation services. Administering your business will be a breeze with the ZenBusiness Money App. And we’ll help you stay on top of state requirements with our Worry-Free Compliance Service. We want you to have the time you need to focus on what’s important to you—making your business a success.
Disclaimer – The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.