If you want to incorporate a business and are trying to decide between a C Corporation and an S Corporation, it’s important to understand the differences and relative advantages of each of these types of business entities. There is no single “right answer” for what is better when considering an S Corp vs. a C Corp. Each entity has some unique upsides, depending on your business goals and what kind of company you want to create.
Before you choose, make sure you know the key differences between these entities, especially the tax implications and the overall flexibility for running your business.
Here are a few of the key elements to consider when evaluating the difference between S Corp and C Corp business structures.
Advantages and Disadvantages of an S Corp or C Corp
The S Corp and C Corp are two of the main types of corporate entities that business owners can choose to incorporate when starting a business or restructuring a business. (The other main form of business entity is the limited liability company, or LLC.)
If you want to run a small business that has only a few business partners or investors, then the S Corp might be the right choice. It tends to offer the best flexibility in how you run your business, without some of the formalities and filing requirements of a C Corporation. Shareholders of an S Corporation can freely transfer their ownership interest in the company without obtaining approval of other shareholders, in a way that is more flexible than selling an owner’s interest in an LLC.
However, the S Corporation still has some limitations that might make it not the right fit for your business. An S Corp cannot have more than 100 shareholders and can only issue one class of stock. Also, an S Corp must be a domestic business entity, and all shareholders must be U.S. citizens or U.S. legal residents.
If you have big ambitions and want your company to grow to become publicly traded, with thousands or millions of shareholders all over the world, then the S Corp is not the right choice of entity and you should incorporate your business as a C Corporation instead.
The C Corporation is often the best choice for businesses that want to get venture capital funding from investors and want to grow and go public. Ownership can be easily transferred by buying and selling stocks, the C Corp can offer multiple classes of stock and issuing stocks can provide funding for the business.
The C Corp, however, has certain legal requirements that are more complex for business owners to comply with. For example, you need to have a formal board of directors, an annual shareholders’ meeting and deal with other ongoing filings and compliance requirements.
Bottom line: if you want your business to stay small, with just a few partners, investors or co-owners, the S Corp might be the best choice of entity. But if you want your business to grow, scale, go public and become a household name in your industry, the C Corp is the best choice of entity for your biggest business goals.
S Corp vs. C Corp Tax Benefits
Some business owners know that they have big visions and aggressive growth targets for their company, so they will want to incorporate as a C Corp from day one. But whatever you choose for your business entity, make sure you understand the tax implications.
If you do not want to grow to the level of having an IPO and if you are satisfied with having only 100 shareholders that are all based in the U.S., then the S Corp can potentially offer you some big tax advantages compared to a C Corp.
Common tax advantages of an S Corp:
- No corporate income tax: The C Corporation has to pay corporate income taxes on corporate revenues, which can cut into profits. The S Corporation is exempt from corporate income tax.
- No “double taxation”: Another tax implication of the C Corporation is that when the company pays a dividend to shareholders, those shareholders typically owe taxes on their dividend income. This is considered a kind of “double taxation” for business owners of C Corporations since the company’s profits get taxed twice — first as corporate income and then a second time as dividend income. Again: the S Corporation is exempt from this “double taxation” on dividends.
- Pass-through taxation: Instead of paying corporate income tax or having to pay taxes on dividends, the S Corp is treated as a “pass-through entity” for tax purposes. This means that, like an LLC or sole proprietorship, the S Corp’s business income simply “passes through” to the business owners’ personal tax returns.
- Flexibility in tax treatment of income: Depending on your marginal income tax bracket and overall tax situation, owning an S Corporation can give you more flexibility in how you characterize your income for tax purposes. With an S Corporation, you can choose to have some of your business income paid to you as an employee salary, and some income paid to you as a “distribution” of income from the business. Setting up your salary and distribution amounts in the right way can help you manage taxes more efficiently and potentially reduce your tax burden. Use the S Corporation Tax Calculator to see how incorporating as an S Corporation (or forming an LLC and electing to be taxed as an S Corporation) can help you potentially lower your self-employment tax bill.
Common tax advantages of a C Corp:
- Lower tax rate: Corporate tax rates were cut significantly as part of the recent new tax law (Tax Cuts and Jobs Act of 2017), making the new rate (21 percent) lower than the maximum personal tax rate (37 percent). This could mean owing less than if the business were set up as an S Corp with taxes being paid at the individual rate.
- Salary and bonuses write-offs: A C Corp can potentially leave no taxable profits to be taxed at the end of the year by paying salaries to shareholders and employees. Keep in mind, the salaries need to be a reasonable amount and the IRS will check.
- Accumulating earnings: C Corporations can defer dividends tax by holding onto up to $250,000 of earnings for a reasonable business need, such as reinvesting back into the company. In an S Corp, these earnings would be taxed to the owners, regardless of how the money is used.
- Charitable donations deductions: C Corps are unique in that they can deduct charitable contributions, as long as it’s not more than 10 percent of the company’s income.
- Deducting fringe benefits: C Corps can deduct benefits, such as health insurance, education assistance and more, reducing the corporation’s taxable income. In most cases, S Corps cannot write off benefits.
Making decisions about salary vs. distribution of business income from an S Corp can be complicated. Consider talking with an accountant or tax attorney about your overall tax obligations before choosing a business entity or before making any changes to your compensation for tax purposes.
Deciding Between an S Corp vs. a C Corp
As you can see, the decision is complicated! Making the right choice for your business depends upon your overall goals for the business. If you are willing to accept a business entity that only allows 100 shareholders who are all U.S. citizens or legal residents and want some unique tax advantages, consider incorporating as an S Corporation (or forming an LLC and electing to be taxed as an S Corp).
If you want your business to grow to a significant level, to the point where you can have an Initial Public Offering and truly become “big,” you should plan on incorporating as a C Corporation. The C Corp is not simple and there are some extra tax obligations compared to an S Corp, but the C Corp is usually the right choice for businesses that have the biggest ambitions for long-term growth.
If you want help making a decision, or are ready to incorporate your business, Incfile can help. We’re here to go over your unique situation and help you pick the best business entity for your needs. We have assisted over 250,000 businesses launch and our expertise can take the guesswork and confusion out of the decision!