S Corp vs. C Corp: What's the Difference?

When it comes to structuring a business, choosing between an S Corporation and a C Corporation can significantly impact your company’s financial and operational dynamics. Both S Corps and C Corps offer distinct advantages and limitations, making it crucial for business owners to understand their differences before making a decision. At the core, the distinction lies in how each entity is taxed and the implications for shareholders.

A financial advisor can help you develop a business financial plan.

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 a 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 from 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.

S Corp vs. C Corp: Similarities and Differences

When deciding on a business structure, understanding the differences between an S Corporation (S Corp) and a C Corporation (C Corp) is crucial. Both are types of corporations that offer limited liability protection, meaning that the personal assets of shareholders are generally protected from business debts and liabilities. However, they differ significantly in terms of taxation, ownership and operational requirements.

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.

S Corp vs. C Corp: Taxes

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 rates. If the S Corp has losses, those flow through to owners as well. The owners can then use those losses on their 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 thing that changed 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 tax returns. C Corp owners can’t do that.

S Corp vs. C Corp: Ownership Differences

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.

When a C Corp Might Make Sense

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 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.

When an S Corp Might Make Sense

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.

Bottom Line

Understanding the differences between an S Corp and a C Corp is crucial for business owners deciding on the best structure for their company. Both types of corporations offer limited liability protection, but they differ significantly in terms of taxation and ownership. An S Corp allows profits and losses to pass through to shareholders’ tax returns, avoiding double taxation. However, it has restrictions on the number and type of shareholders, which can limit growth potential.

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 a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel 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 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.