If you’re ready to take your small business to the next level and establish it legally, you’ve got an important decision to make. How would you like to structure your business? While there are numerous options to choose from, S-Corporations and C-Corporations are among the most common. Because this choice is so impactful, you may want to consult a business lawyer. They can help you with this and other legal aspects of your business.
Folks tend to confuse S-Corps and C-Corps, which is understandable; the names are so similar. However, despite the similar names, the two are actually quite different. It’s essential to understand how each one operates before you choose a structure for your small business.
The Basics of Corporations
C- and S-Corps have a lot in common. They’re both formed by preparing articles of incorporation, then filing state-specific registration documents. Their general structure looks like this:
- Shareholders are the owners of a corporation.
- They elect directors to oversee the business.
- The directors then hire officers to take care of the day-to-day operations.
- Profits are dolled out to shareholders depending on how many shares each of them owns.
All corporations must:
- Issue stock
- Adopt by-laws
- Hold annual director and shareholder meetings and keep minutes of the meetings
- Issue written resolutions for important decisions
- File annual reports with the state government
- Pay annual fees
Finally, both S- and C-corp ownership require you to establish and maintain business credit if you want funding and business loans.
What is a C-Corporation?
The IRS recognizes a C-Corp as the standard corporation. Its name comes from Subchapter C from the Internal Revenue Code.
Almost all publicly traded companies are C-Corporations. Some of these companies include:
- General Motors
What is an S-Corporation?
S-Corps have a special tax status with the IRS that gives them certain advantages. To become an S-Corp, you must first establish yourself as an LLC or C-Corp, then file Form 2553 with the IRS and ensure you meet all the guidelines. These guidelines include:
- Corporation must be domestic
- No more than 100 shareholders
- One class of stock issued
- Allowable shareholders only (No partnerships, corporations, or non-resident alien shareholders)
- Must not be an ineligible institution (some financial, insurance, and domestic international sales companies)
Small businesses tend to choose the S-Corp route. They usually have few shareholders and can’t afford corporate taxes or double taxation. When it comes to a new business, the margin for error is minuscule. Access to capital and low-interest rates are vital, so in addition to saving on taxes, learn how to qualify for Small Business Loans.
C-Corp vs. S-Corp: How Are They Different?
The differences between an S-Corp and a C-Corp are most apparent in three key areas:
- C-Corp: This is easier to form than an S-Corp. There’s less paperwork and fewer requirements to qualify. When you file the articles of incorporation, the default status is C-Corp. This designation isn’t perfect for all businesses, though, only those that aspire to be a huge company.
- S-Corp: S-Corps can only have 100 shareholders. This isn’t a problem for most corporations, especially those that care about shareholders’ opinions. If you want them to be more involved in the company and aware of what’s going on, fewer is better. However, to become an S-Corp, you have to file a lot more paperwork and adhere to strict rules.
- C-Corp: You can deduct certain employee benefits and all your charitable contributions and donations up to 10% of your total income. However, you will be taxed twice. The company’s revenue is taxed, and you’re taxed for it again on your personal return. You lose money on earned revenue. Corporate taxes cut into small businesses’ earnings, which often kills them. There are two ways to avoid double taxation: make no money or reinvest all earnings back into the company.
- S-Corp: Tax benefits are the primary advantage of becoming an S-Corp. Owners report business income and loss on their personal tax returns and can deduct up to 20% of that income. The IRS scrutinizes S-Corp filings very heavily. If a mistake is found, your status may be canceled.
- C-Corp: Unrestricted ownership makes stock sales and selling your company easier. Your business must be managed correctly to maintain your C-Corp ownership status.
- S-Corp: The limited ownership of an S-Corp helps you avoid a ranking order of shareholders and ensure owners value the company and those who it employs. However, if you plan to sell or be acquired, S-Corps can’t be owned by many types of businesses.
How to Choose for Your Small Business
Now that you know the differences between C-Corps and S-Corps, you can fully understand why one is chosen over the other. Of course, the right choice for you depends on your situation, but here is some advice to help you decide.
- Consider acquisition. If you plan to sell your company one day, C-Corp status may be for you. S-Corps can’t be owned by other companies.
- What’s your desired size? Do you want a small number of shareholders who care about the company and an intimate, small business feel forever? Choose an S-Corp. Do you want to grow into a monster-size company? Choose a C-Corp.
- Double taxation. Can you afford to be taxed twice? Can you afford the corporate tax rate? If not, S-Corp is for you.
- IRS scrutiny. If you don’t mind extra paperwork and you’re willing to be subject to extra scrutiny by the IRS, an S-Corp will work for you. If being watched by the IRS and following rules is hard for you, filing as a C-Corp is best.
If your budding small business is still in the initial phase of deciding on structure, you may also need more access to capital and business loans. At AdvancePoint Capital, helping small businesses get the money they need to succeed is our specialty. Learn which small business loans you qualify for and get approved for funding today.