S-corporations and C-corporations are two different types of business structures that are recognized under U.S. federal tax law. Both types of corporations provide limited liability protection to their shareholders, which means that shareholders are not personally liable for the company’s debts and liabilities. However, there are some key differences between the two types of corporations that can have a significant impact on how the business is taxed and operated.
Differences between C-Corporations & S-Corporations
One of the main differences between S-corporations and C-corporations is the way they are taxed. C-corporations are considered to be separate entities from their shareholders, and they are subject to corporate income tax on their profits. In contrast, S-corporations are considered to be “pass-through” entities, which means that the company’s profits are passed through to its shareholders and taxed at the individual level.
This pass-through taxation can be a significant advantage for S-corporations, as it can help to avoid the “double taxation” that can occur with C-corporations. For example, if a C-corporation earns $100,000 in profits, it would be taxed at the corporate level, leaving $70,000 after corporate taxes. If the company then distributes the remaining $70,000 to its shareholders as dividends, the shareholders would then have to pay personal income tax on those dividends. With an S-corporation, the $100,000 in profits would be passed through to the shareholders and taxed at the individual level, avoiding the additional corporate tax.
Another difference between S-corporations and C-corporations is the number of shareholders they can have. S-corporations are limited to 100 shareholders, while C-corporations can have an unlimited number of shareholders. This can be a significant consideration for companies that are planning to go public or that have a large number of investors.
There are also some restrictions on the types of shareholders that S-corporations can have. For example, S-corporations cannot have non-resident alien shareholders, and they cannot have more than one class of stock. This can limit the flexibility of the business in terms of raising capital and issuing stock options.
In terms of flexibility and management, C-corporations can have a board of directors, while S-corporations cannot. However, S-corporations can have more flexibility in terms of profit distribution. Unlike C-corporations, S-corporations are not required to distribute profits equally among shareholders, and they can choose to retain profits in the business if they wish.
Complexity and Disadvantages
One of the main disadvantages of S-corporations is that they can be more complex to set up and maintain than other types of business structures, such as sole proprietorships or partnerships. They are also subject to more regulatory requirements, such as holding annual meetings and keeping detailed records of the company’s financial and operational activities.
C-corporations also have their own advantages and disadvantages. They are considered more stable and with more prestige. They can also raise capital more easily and attract more investors, but it comes with the trade-off of double taxation.
Choosing Which Corporation
In conclusion, whether to choose an S-corporation or C-corporation depends on the company’s specific needs and goals. S-corporations can be a good option for small businesses that want to avoid double taxation and have a relatively small number of shareholders. However, they may not be the best option for companies that are planning to go public or have a large number of shareholders, as they have restrictions on the number of shareholders and types of shareholders they can have. C-corporations, on the other hand, may be a better option for larger companies that plan to raise capital and have more flexibility in terms of profit distribution and management structure. It’s important to consider all aspects of each type of corporation, weigh the pros and cons, and seek legal advice to determine which structure best suits your business. Please call Brenden Kelley Law at 216-644-3359 so that we can assist you starting your business.