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What Are the Differences Between Sub-Chapter C and S Corporations?

When you start to develop how you want your business to be set up, you have a few different options to choose from. Some will go with an LLC, while others will look into an S Corporation or C Corporation.  

While they only have one letter difference, how they operate aren’t exactly the same. Here’s how to tell the difference, as well as what works the same between the two entities. 

Difference Between C Corp vs S Corp 

There are three main differentiators when it comes to S Corporations and C Corporations: formation, taxation, and ownership. 

Formation — C Corporations are considered the default type of corporation. When you file articles of incorporation in your state, you’re designated a C Corp. If you want to be an S Corporation, you’ll need to file Form 2553. There might be other forms to complete to stay an S Corp as well. 

Taxation — C Corporations get taxed twice: the company pays corporate income tax and shareholders pay federal income taxes through dividends. S Corporations have pass-through taxation. This is when shareholders report business income and losses on a personal tax return. So the only taxes they face are the ones on their personal tax return. There’s no corporate tax. 

Ownership — C Corps don’t have restrictions when it comes to ownership. Anyone can be an owner, and there can be as many owners as you’d like. S Corps are limited to 100 shareholders who must be U.S. citizens.  

C Corporation vs. S Corporation: The Similarities 

Limited liability protection – This type of protection means shareholders aren’t responsible for a company’s business debts or financial obligations. Both S Corps and C Corps benefit from limited liability protection. If anything were to happen to your company, you wouldn’t have to personally pay out of pocket for expensive financial responsibilities or other debt the company has accumulated. This isn’t the case if you were to have a sole proprietorship. 

Separate legal entities – Both C Corporations and S Corporations have the option to use separate legal entities. This is when a company operates as a separate entity from its original company. Separate entities ensure separate liability from its ownership. Separate entities have a corporate shield, or a veil of protection from liability.  

Filing documents – When you file your articles of incorporation with your state, the documents will be the same regardless of if you’re filing as a C Corp or S Corporation. While filing for an S Corp requires a bit more documentation, the articles of incorporation are the same. 

Structure – Both types of corporations allow for their own shareholders and ownership setup. S Corps and C Corps alike are incorporated the same way, as well as issue stock and adopt bylaws. Both S Corps and C Corps have boards of directors with directors and officers and file annual reports. 

Corporate formalities – Both have similar corporate structures, even though shareholders own the company. For instance, company business is managed by the CEO and the team they put together. Boards of directors handle policy and management concerns. 

Picking between C Corp and S Corp: Which Is Best for Your Small Business? 

Even though C Corporations are the default company filing status, they’re not necessarily right for every business. When you’re deciding which status to choose, ask yourself a few questions, like: 

Do I want my company to get acquired?  

If you’re hoping to one day sell your company to another one, you might want to become a C Corp. Since C Corporations have the ability to be owned by other types of companies, it makes acquisitions much easier in the long run. Along with that, you can have any many owners as you’d like and many different classes of shareholders.  

Do I want to limit my shareholders? 

Some companies aren’t made for huge expansions. Some small businesses want to stay that way. Since S Corporations are limited to 100 shareholders and they have to be U.S. citizens, you might feel like that’s enough of a setup for your company. But keep in mind that even with the 100 shareholder limit, S Corporations tend to put more emphasis on shareholder input. You might like the smaller setup. Otherwise, consider filing as a C Corporation if you think your company could face significant growth later on. 

Is double taxation worth it?  

The biggest differentiator between S Corps and C Corps is that C Corporations face a corporate tax. If you’re comfortable with getting taxed at the corporate level and then again at the personal level, you shouldn’t have an issue with becoming a C Corp. However, if you’d prefer to save on corporate taxes and handle profit and losses through your personal income tax, you can.  

Am I OK with the extra scrutiny?  

Since the default filing for corporations is C Corps, there’s an extra layer of paperwork to complete for S Corps. Along with that, becoming an S Corporation means you’re subjected to an extra-careful watchful eye from the IRS. You’ll need to make sure you keep a squeaky-clean record, since even one small mistake, like going over the 100-shareholder limit, could cause you to lose your S Corporation status. If you can handle the idea that the IRS is always watching and you don’t feel like you’d have a hard time following the rules, an S Corp might work for you. Otherwise, consider filing as a C Corporation. 

How you plan to set up and run your business depends on the type of company you want to run, what you envision for the future and the comfort level of ownership and taxes you’re willing to take on. Make sure you get legal advice from a trusted solicitor like Steger Law Firm before making any commitments. 

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