Are you forming a corporation for your business, and you’re wondering which tax structure you should use?
You may already know that the two different forms of corporation taxation are the C corporation and the S corporation, but what are the differences between them?
Furthermore, are you even eligible to choose between the C corp and the S corp, or is your specific corporation only eligible for one of these options?
We get lots of questions from our readers regarding the details of the C corporation and the S corporation, so in this guide, we’ll take aim at answering even your toughest questions about these tax entities.
If you’re trying to figure out whether the C corp or the S corp is the right choice for your business, read on to discover all the relevant information.
What Is a Corporation?
Before we get into the details that set the C corporation and the S corporation apart, let’s quickly discuss what the corporation is as a business entity.
A corporation is a formal, legal business structure that is a separate and distinct entity from its owners. The ownership of a corporation is comprised of its shareholders, who can each own varying shares of the company.
To form a corporation, you’ll need to prepare and file a document known as the articles of incorporation. The articles include basic information about your business ― like the street address, business name, and the identity of your registered agent ― along with some more in-depth details.
You should also create the corporate bylaws document to describe how your business will operate, hold an initial board of directors meeting, and issue stock certificates.
One of the most attractive aspects of the corporation is the personal asset protection it provides. The corporation can limit your personal liability by protecting your personal assets ― like your home, vehicles, personal checking and savings accounts, etc. ― from creditors who sue your business.
In this way, even a successful lawsuit only allows creditors to pursue your business assets, while your personal assets are safely shielded from them.
What Are the C Corporation and S Corporation?
The two main types of corporations are the C corp and the S corp. The C corporation is by far the more common of the two, and it is the standard default tax structure for the Internal Revenue Service, while the S corp is a special election that has some specific eligibility requirements.
In general, the C corporation and S corporation are nearly identical in every way except for the way they’re handled for tax purposes, as the basic tenets of the corporation apply to them both. Here’s an overview of the ways these two types of corporations vary as tax entities.
The majority of corporations are classified as C corps, partially because it’s the default option, and also because there are far fewer rules and regulations governing the C corp than the S corp.
The C corporation pays taxes at both the corporate level and at the individual level, which is often referred to as “double taxation.” With this model, your business income is taxed 21% at the corporate level, and then you also pay taxes on that same income again on your individual return.
The S corporation is taxed more like a general partnership or a limited liability company, in that it is considered to be a pass-through entity. This means that instead of the double taxation model of the C corporation, the S corp has its income “pass through” the business structure itself, and there is no tax paid on the corporate level. Instead, the only taxes paid by an S corp’s owners are on their personal tax returns.
The reason there aren’t more S corporations than C corporations is because the S corp has some pretty strict corporate ownership guidelines. The S corp cannot have more than 100 shareholders, regardless of how many shares those owners have. In addition, every one of an S corporation’s shareholders must be a citizen or resident of the United States.
Beyond the shareholder restrictions, your corporation will not qualify for S corp status if it is owned in part or whole by any other corporation (whether an S corp or C corp), limited liability company, or partnership. An S corporation is also not allowed to have more than one class of stock.
How to Elect the S Corporation Tax Structure
If your corporation qualifies for S corp election, and you think this is the preferred option for your business, you can apply to be an S corporation through the IRS.
By filing the Form 2553, you can choose the S corp entity for tax purposes. This form needs to be filed by March 15th if you want your S corp election to take effect in the current tax year, or you can file it anytime if you are willing to wait until next year.
How to Form a Corporation
Forming a corporation is essentially the same process for either a C corporation or an S corporation. The only noteworthy difference is that the S corp should file IRS Form 2553 after completing the other formation steps.
The main requirement for forming either type of corporation is drafting the articles of incorporation and submitting them to your state government.
If you would rather not take the DIY route for your corporation formation, there are other options. Depending on the complexity and size of your corporation, it might be a good idea to hire an attorney to form it. This can be very expensive, but it can also be a great way to make sure that your formation is handled in a proper and compliant manner.
Another popular route is to hire a business formation service to handle this important role. There are many companies out there that can reliably form a corporation for you, which is typically a much less expensive option than hiring a lawyer. At the same time, these companies can still provide the peace of mind that makes hiring an attorney an appealing option in the first place.
If you’re interested in having a business formation service form your C corp or S corp, check out services like ZenBusiness, LegalZoom or Northwest.
The C corporation and S corporation are essentially the exact same business structure, but the S corp operates under far more restrictions regarding ownership and eligibility.
Every corporation is different, but for the most part, the S corp can save you some tax money if your business is eligible for this election, due to the way it avoids the double taxation model of the C corp.
We hope this article helped answer your tough questions about the C corporation and the S corporation, and we wish you the best of luck!