S Corp Vs C Corp: What Are The Major Differences?
A corporation can be of different types, the most common ones being S corporation and C corporation. To change the structure of your business to a corporation, you will need to file articles of incorporation for the business with the state where the business is located. After a business becomes a corporation, the owners become shareholders (limited liability). The tax system of the business also changes as per its structure. In this article, you will learn about S corporations and C corporations and how they work in different situations and scenarios. You will learn here about the major factors that are unique to each of these types of corporations. Finally, we will discuss the major differences between each of these types of corporations. To learn which of the two is better for you (S Corp vs C Corp), read on through to the end of the article.
What Is An S Corp?
“An S corp or S corporation is a business structure that is permitted under the tax code to pass its taxable income, credits, deductions, and losses directly to its shareholders. That gives it certain advantages over the more common C corp, The S corp is available only to small businesses with 100 or fewer shareholders and is an alternative to the limited liability company (LLC).”
Like LLCs, S corporations are called “pass-through entities,” since there are no corporate taxes for the business. However, the businesses pay their shareholders, who are responsible for the taxes that are due. The shareholders of S corporations are mostly individuals, certain trusts and estates, or other tax-exempt organizations.
These corporations are known as S corporations since they belong to the Subchapter S of the Internal Revenue Code. As per the code, these corporations are under taxation.
How Does An S Corp Operate?
If any corporation is under subchapter S of the IRC, then it is permitted to pass its business income, deductions, losses, and other credits to its shareholders without paying federal taxes. This makes S corporations a pass-through entity, as they get special tax benefits under the Tax Cuts and Jobs Act, 2017. However, for some built-in gains and passive income, there are some corporate taxes applicable.
What Is A C Corp?
According to the Forbes Advisor,
“A C-corp is the most common corporate tax status. Like the S-corp, it gets its name from the subchapter of the Internal Revenue Code under which it’s taxed. Tax requirements are the key attributes that make a C-corp a C-corp and an S-corp an S-corp. A corporate income tax is first paid by a C-corp with a federal return (Form 1120) required by the IRS.”
However, after that payment, shareholders must also pay their taxes on their personal income at their individual levels if they have gained from sales of stocks or dividends. This is double taxation, and it applies because the taxes are applicable both at the individual and the corporate levels. Furthermore, the shareholders of C corporations also do not have permission to write off their corporate losses by offsetting other income on personal income statements.
One of the major aspects of C corporations that make them desirable among business owners is that there are no restrictions on who can own the shares of the business. For a corporation. other businesses and entities both inside and outside the United States can own shares of a C corporation. Furthermore, there is also no limit to the number of shareholders in the corporation. The shareholders of C corps also get full liability protections of any corporation.
How Does A C Corp Work?
In a C corporation, the stocks are issued to shareholders of the company, and the company is run by a board of directors. The major shareholders of the company vote for the members who will be a part of the board of directors.
The features that define C corporations include their liability and tax treatments. C corporations shield the shareholders of the business from any debt-related or function-related liabilities. In case of a lawsuit against a C corp, the personal assets of the shareholders remain protected.
When it comes to taxes, the C corp has to pay corporate income, and the shareholders of the company also need to pay taxes on income they made through sales of dividends. Hence, C corporations get double taxation from the IRS.
According to the Corporate Finance Institute,
“A C Corporation is the default designation provided to a freshly incorporated company. Any corporation may choose to convert into an S Corporation at any point in time, given that it receives the consent of all its shareholders to file for S status. The provisions allotting S status to companies are enumerated in Subchapter S of Chapter 1 of the Internal Revenue Code, which is where the term S Corporation comes from.”
The following are the major differences between S corps and C corps:
|S Corp||C Corp|
|Requires Articles of Incorporation and IRS Form 2553||Requires Articles of Incorporation|
|Single-layer taxation (Pass-through)||Double taxation (corporate income and personal income)|
|If criteria are met in taxation, taxes can be written off||Taxes cannot be written off on personal tax returns|
|Maximum 100 shareholders (only domestic)||Unlimited number of shareholders (both domestic and international)|
|Only one class of stock||Multiple classes of stocks|
S Corp vs C Corp – Hope this article was helpful in understanding the difference between these two types of corporations. The main difference between the two lies in their liability of federal income tax and the ownership of the corporation in question. While an S corporation is a pass-through entity, C corps are separate taxable entities that go through double taxation.
It is essential for businesses to understand the differences between these types of corporations so that they make the right decisions at the early stage regarding the structure of the business. These will affect a business’s long-term payouts to shareholders. Which business structure do you think is the best option for your business? Share your ideas in the comments section.
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