What is the Difference Between a C Corp and an S Corp?
Small business owners often have the option to designate their corporation as an S Corporation or a C Corporation. Each option has many similarities but key differences in federal tax treatment that may provide advantages to your business goals.
A C Corporation, also referred to as a regular corporation, is automatically formed when a business incorporates. While an S Corporation must file paperwork with the IRS when electing for special tax status, a C Corp does not. Both share many qualities including limited liability protection, filing documentation, structure, and corporate formalities. Both offer limited liability protection for shareholders who generally are not personally liable for business debts and liabilities. Each form is also a separate legal entity created by proper filings in the state of incorporation, this is typically the articles of incorporation or the certificate of incorporation.
Both forms have the customary corporate structure with shareholders, directors, and officers. Each must also follow the statutory corporate formalities which include adopting bylaws, issuing stock, holding shareholder and director meetings, filing annual reports, and paying annual fees.
While taxation rules are the primary difference between an S and C corporations, there are also important restrictions on corporate ownerships for an S Corporation. Whereas a C Corporation has no restrictions on ownership, an S Corporation is restricted to no more than 100 shareholders. Shareholders must also be US citizens and cannot be another corporation, LLC, partnership, or trust. S Corporations must only have one class of stock as opposed to the flexibility in stock classes for a C Corporation. Also where a C Corp (and the employees receiving the benefit) can deduct the cost of fringe benefits provided to employees such as health and disability insurance, an S Corp and those employees receiving benefits cannot deduct fringe benefits for shareholders who own more than 2 percent of the shares.
Taxation rules are considered the most significant difference for small business owners when evaluating S Corporations or C Corporations for their business structure. C Corporations are separately taxable entities, which files and pays a corporate tax return. There is often double taxation when corporate income is distributed to business owners as dividends which is taxed again at the personal income level for the shareholder. An S Corporation is taxed similarly as an LLC as a pass through tax entity. S Corps must still file a information report annually but no corporate income tax is levied. The income is passed through to the shareholders on their personal income returns.
To become an S Corporation you must file Form 2553 with the IRS, this is called S Corp election. Election to S Corporation status must be done before March 15th to be effective the year of filing. There are no further requirements in Texas for S Corp election.
A C Corporation has more flexibility for shareholder rights and ownership but face tax implications for this privilege. Incorporation and tax election is an important consideration for any small business, be sure to call Reidel Law Firm for a free consultation on your options and what may be best for yourself and business. Use the form below or call us at (832) 510-3292.
