Several factors distinguish S Corp vs C Corp tax advantages. Choosing to become a C Corp or S Corp can have a sizable effect on a business’s future, growth, and investor base. There’s no easy answer to whether a C Corp or S Corp is the best choice. To pick wisely, entrepreneurs have to consider several interlocking variables. A financial advisor could help you develop a financial plan for your personal and business needs.
An Overview of How Businesses Are Taxed
Starting a business is a big decision. But it’s just one of many to follow. Most importantly, you’ll decide which type of entity your business should be. Among several choices including sole proprietorship, partnership and limited liability company (LLC), a corporation is one of the most popular choices.
Corporations offer some key advantages over other business entities. For starters, unlike partnerships and sole proprietorships, the owners aren’t personally liable for the business’s debts. A corporation is also usually the best choice if you plan to grow a company to considerable size.
However, choosing to incorporate isn’t the end of it. Entrepreneurs also need to choose what kind of corporation to become. The choices – C Corp and S Corp – get their names form the relevant section of the Internal Revenue Code that governs how they are taxed. But there is more than a single letter’s difference between them.
Similarities and Differences of C Corps and S Corps
Both types of corporations are incorporated the same. State laws govern incorporation and state business organization laws treat all corporations the same. Both offer the important advantage of limited liability.
C Corps and S Corps have similar requirements for adopting bylaws, issuing shares of stock, holding meetings of shareholders and directors, filing annual reports and paying fees. They are organized similarly, with boards of directors, directors, officers and shareholder owners.
The first major difference is that you don’t have to do anything to be a C Corp. That is the default tax status the IRS assigns to corporations.
You can, however, choose an S Corp tax structure. To do this, file IRS Form 2553 after incorporating.
Tax Advantages of S Corps and C Corps
The next major difference concerns taxes. C Corps are subject to double taxation. The corporation pays federal income taxes on net income. The shareholders pay federal income taxes again on any dividends they receive.
S Corps, on the other hand, are pass-through entities. The S Corp doesn’t pay taxes. Instead, any profits flow untaxed to the owners, who pay income taxes at their individual rates.
If the S Corp has losses, those flow through to owners as well. The owners can then use those losses on their individual returns to shelter income from other sources. C Corps can’t pass on losses to owners.
While C Corp profits are taxed twice, since the 2017 Tax Cuts and Jobs Act was signed into law, C Corp taxes are a flat 21%. Individual federal income tax rates can go as high as 37%.
Another change with the 2017 tax law is that owners of pass-through entities like S Corps may be able to deduct 20% of the business income from their individual tax returns. C Corp owners can’t do that.
The third big difference is ownership. C Corps have no ownership restrictions. They can have as many owners as they like, and anyone can be an owner.
S Corps can only have 100 shareholders. And owners have to be U.S. citizens.
C Corps can also issue multiple classes of stock, such as common and preferred shares. S Corps can only have one class.
Who Should Choose a C Corp?
A C Corp may be the best choice for a business that seeks investment from venture or angel investors. It also may work for businesses that plan to to grow large enough to someday have an IPO or acquisition occur. This is because of the lack of restrictions on ownership and share classes.
A C Corp may also make sense if the business reinvests most or all profits rather than distributing them as dividends. That avoids double taxation.
C Corps can also look good for businesses that have lots of fringe benefits or plan large charitable contributions. C Corps can claim benefits and donations as deductions but S Corps face limits.
Who Should Choose an S Corp?
An S Corp is the most tax-efficient option for many small business owners because it avoids double taxation. For a small business that can get the qualified business income deduction, an S Corps could be even more attractive.
An S Corp might make sense for early stage businesses that anticipate losses that can pass through to owners as tax deductions. Owners who work in the business and draw a salary might choose an S Corps because it can help minimize self-employment taxes.
The decision to opt for C Corp or S Corp status can have significant effects on a business’s ability to recruit investors and save on taxes. But there’s no one-size-fits-all answer. It’s necessary to compare pluses and minuses of each to choose the best for any given business.
Business Tax Tips
- If parsing S Corp vs C Corp tax advantages for your business still has you puzzled, consider talking to a financial advisor. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- S Corp vs C Corp tax advantages are have significant differences when taxed. If you’re a small business owner trying to figure out your business’ tax situation, SmartAsset’s small business tax guide can explain the basics.
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