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S Corporation Vs. C Corporation: Which One Is Right For You

S Corporation Vs. C Corporation: Which One Is Right For You

When you start a business or change its structure, one of the most common options that business owners evaluate is the creation of an S corp (S corporation) or C corp (C corporation). These are the two most common forms of incorporation, and the choice depends on the goals of the company.

S Corporation Vs. C Corporation: the similarities

C Corporation is the standard companies corporation, while S corporation has a special tax status with the IRS. It got its name because it is defined in subchapter S of the Internal Revenue code. To choose S corporation status when creating a corporation, the Form 2553 must be submitted to the IRS and comply with all of S corporation guidelines. But C & S corporations have many similar qualities:

  • Limited Liability Protection: Both offer limited liability protection; therefore, shareholders (owners) are generally not personally liable for the debts and financial responsibilities.
  • Separate Entities: S corp and C corp are separate legal entities created by a state filing.
  • Document Filing: Company formation documents must be filed with the state. These documents, commonly called status or certificate of incorporation, are the same for C and S Corporation.
  • Structure: Both have shareholders, directors, and officers. Shareholders own the company and elect the board of directors, which in turn oversees and manages the company's business and decision-making, but is not responsible for day-to-day activities. Administrators choose managers to manage daily activity.
  • Company Procedures: Both are required to comply with the same internal and external formalities and obligations, such as the adoption of articles of association, the issuance of shares, the organization of shareholder and director meetings, the submission of annual reports and the payment of yearly commissions.

S Corporation Vs. C Corporation: The Differences

Despite their many similarities, S corporations and C corporations also have clear differences.

  • Taxation: Taxes are often known to be the most significant difference for small business owners when evaluating S corporations versus C corporations.
  • C corporations: C corporations are entities subject to separate taxes. They file a tax return (Form 1120) and pay income tax. They also face the risk of double taxation, if corporate income is distributed to business owners in the form of dividends, which are considered personal income. Corporate income tax is paid first at the company level and then at the individual level for dividends.
  • S corporations: S corporations are transfer tax entities. They file a federal informational return (Form 1120S), but no corporate income tax is payable. Instead, the profits/losses of the corporation are "transferred" and reported in the owners' tax returns. All taxes due are paid individually by the owners.
  • Personal Income Tax: In both types of corporations, the income tax is due to the company's salary and dividends received by the company.

Corporations Ownership: C corporations do not have ownership restrictions, but S corporations do. The bodies are limited to a maximum of 100 shareholders, who must be citizens/residents of the United States. S corporations cannot be owned by C Corporation, other S corporations, LLCs, partnerships, or many trusts. Also, S corporations can only have a single class of shares (regardless of voting rights), while C corporations can have several classes. As a result, C corporations offer a little more flexibility when you start a business, whether you want to expand the ownership, grow, or sell your corporation.

S Corporation (S Corp) Election

To become an S corporation, you must submit Form 2553 to the IRS. The IRS instructions, which may be somewhat challenging to follow, require that the choices be considered effective for the current fiscal year only if Form 2553 is completed and submitted:

  • At any defined period before the 16th day of the 3rd month (for taxpayers of the calendar year, this means that it must take place before March 15th)
  • At any time in the previous fiscal year (however, elections held within two months and 15 days from the beginning of a fiscal year of fewer than 2½ months are considered appropriate for the year in question).

As a rule, choices made after the third month, but before the end of the fiscal year, are effective for the next fiscal year (unless it is shown that the lack of timely submission was due to a specific reason reasonable).

Keep in mind that some states may also require you to file an election with state-owned S corporation after joining the company.

BRIAN PRZYSTUP & ASSOCIATES LLC
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