At Remitly, we’re supporters of small-business owners. If you’re new to the US and looking to set up a corporation, there are important differences between S corps and C corps. This guide will help you differentiate between the two business structures so you can make an informed decision about which is best for you.
Comparing S and C corporations
In the US, a corporation is a legal entity that is distinct from its owners, formed with the express intention of conducting business. Under the umbrella of corporations, S corporations and C corporations are two business structures that you can consider if you’re setting up your own business.
Both S and C corporations provide business owners with limited liability protection, meaning the personal assets of their shareholders are protected in the event of legal claims or business debts. However, the two vary significantly in ownership and taxation rules. Read on to learn more.
Overview of S corporations
In S corporations, profits and losses are passed through to shareholders. They must then report the gains and losses on their personal income tax returns. This avoids double taxation.
All shareholders of an S corporation must be US citizens or residents. An S corporation can have a maximum of 100 shareholders (certain family members can be considered as a single shareholder).
Overview of C corporations
C corporations are taxed separately from their owners at the corporate level. When profits are distributed to shareholders, they must be reported again on their personal income tax returns.
Unlike those of S corporations, shareholders of C corporations are unlimited in number and nationality. C corporations can have international investors.
Key differences between S and C corporations
Besides taxation and ownership, S and C corporations have some other key differences that affect how the business operates and grows.
Issuing stock
S corps can only issue one class of stock. Essentially, this means that anyone who has ownership of the company has identical rights to distributions and liquidation proceeds (voting rights may differ). On the other hand, C corps can issue multiple classes of stock with varying levels of investor involvement.
Accounting style
Generally, S corps can use the cash-basis method of accounting. This means that profits and losses are recorded in real time, when payments are made or received.
C corps typically have to follow the accrual method of accounting unless they meet certain criteria to be considered a small business. The accrual method accounts for profits at the time the revenue is earned or at the time the action is performed. Similarly, expenses are accounted for at the time that the liability is incurred. The accrual method keeps a running balance regardless of when cash is received or paid.
Complexity
In general, S corps have simpler compliance requirements than C corps—for example, they have lower administrative burdens when it comes to taxation.
Choosing the right business structure for your company
Selecting the right business structure is one way to ensure that your company is set up for success. Deciding between an S corp and a C corp can be tricky. Here are some things to consider as you move forward. Remember, you can always restructure your business if needed.
Factors to consider in selecting a business structure
Your business structure should reflect your business as naturally as possible. Think about your business in terms of the following:
- Taxes: Different business structures are taxed differently. This variable tax burden can affect profitability. It can also mean the difference between a few extra steps on your tax return or a separate tax process for your business.
- Liability: While corporations and LLCs (Limited Liability Companies) protect owners from personal liability, sole proprietorships and general partnerships don’t. Think about how much protection and legal separation you want between you and your business.
- Ease of administration: Some business structures are easier to set up and run than others. Compliance requirements can be different depending on which business structure you choose. Consider how much time and energy you can spend on administrative tasks and whether or not you’re going to outsource administrative tasks.
- Financing: If you’re raising capital for your business or looking for investors, how you can go about that depends on your business structure.
- Long-term goals: Think about the size and scope of your business and how you’d like it to grow in the future. Your business structure can influence how your business can grow and change.
- Business size: The size of your business, both now and in the future, might influence your decision about business structure.
When to consider an S corp
S corporations generally offer simpler compliance requirements and are easier to set up than a C corp. An S corp is a great choice for small businesses and owner-operated businesses. If you prefer a simpler taxation process, an S corp is for you.
When to consider a C corp
If your business is larger or international, a C corporation will better suit its needs. If you’re seeking venture capital for a startup, a C corp facilitates investors more easily. For this same reason, C corps are also a good choice for businesses looking to go public.
Pros and cons of S and C corps
There are a lot of factors to consider when you’re choosing between S corps and C corps. To make things a bit more straightforward, we’re highlighting the top three pros and cons of each business structure.
Advantages of S corps
- Pass-through taxation to shareholders, who file personal income tax as usual
- Relatively easy to incorporate and remain compliant compared to C corps
- Can use the cash method for accounting, unless restricted by inventory rules or revenue limits
Disadvantages of S corps
- Constraints on shareholders could limit business growth.
- Inability to welcome international investors
- Less flexibility in terms of complicated ownership
Advantages of C corps
- Unlimited owners and shareholders from any country
- Ability to issue different classes of stock
- Great for business growth and larger companies
Disadvantages of C corps
- Double taxation at both the corporate and shareholder level
- Requires administrative attention and knowledge to set up and remain compliant
- Typically uses the accrual method of accounting, which is considered more complicated
Tax implications of your business structure
One of the main differences between S corps and C corps is how they are taxed. S corps were created to enjoy the liability protection of a corporation without facing double taxation. Understanding how tax works in each business structure will help you decide which is right for you.
Understanding pass-through taxation
Pass-through taxation refers to businesses that do not have to pay taxes on the corporate or entity level. The top benefit of S corps is that they can use this method.
This means that income passes to the shareholders, who then file it on their personal tax returns. Essentially, an S corp provides the benefits of a formalized business structure without having to pay corporate-level income tax.
Double taxation in C corporations
Double taxation refers to the taxation at both the entity level and the personal level. Business income of a C corp is taxed at the entity level. Then, when shareholders receive dividends, they have to be reported on personal income tax returns, thus being taxed again.
In practice, corporations may reduce their taxable income through reinvestment or deductions. Some shareholders may not need to pay tax on dividends. If you’re not familiar with US tax laws and are thinking about a C corp, outsourcing to a tax professional could be worthwhile.
Impact on personal tax returns
If you’re a shareholder of an S corp, your share of the business’s income, deductions, and credits must be reported on your personal tax return.
C-corp shareholders just report dividends received on their returns.
Liability and legal considerations
One major benefit of formalizing your business through incorporation is protecting your personal assets. Both S and C corporations provide limited liability, shielding owners from being personally responsible for business debt or legal obligations.
Limited liability protection for business owners
Limited liability is provided when a separate legal entity is created for a business. S and C corps are two ways to create a separate legal entity for your company. Just as each US citizen has a Social Security number, businesses with their own legal entity have a separate identification number used for tax purposes, opening bank accounts, and so on.
Protecting personal assets
This means that the owners are protected if the business suffers financial difficulties or is sued. The business assets can be pursued, but the owners’ personal funds and assets cannot be involved—so things like your home, cars, and personal bank accounts will remain safe from lawsuits or creditors.
Next steps for your business
If you’re ready to incorporate your business, follow these steps to get the ball rolling.
Steps for incorporating as an S corporation
If you’ve decided that an S corp is right for you and your business, it’s pretty easy to get started.
- Choose a business name. Each US state has a database of existing businesses. Use this database to choose a name for your business that is not already in use.
- Set up your legal business entity. To be taxed as an S corp, you have to register as an LLC or legal corporation first. You will then select S-Corp status for tax purposes. Each state has its own process for business formation and accompanying fees. At this stage, depending on state requirements, you may also be required to designate a registered agent for your business.
- Apply for an Employer Identification Number (EIN). The EIN is the identification number for your business, much like your Social Security number is your personal identification. You can apply for an EIN through the IRS website.
- Submit Form 2553 for S-corp taxation. Once you’ve set up your business and have an EIN, you can fill out Form 2553 to let the IRS know that you’ll be electing to operate as an S corporation. Note that all shareholders must consent to this election.
- Complete any state or local requirements. Depending on your state and location, you might have to file for additional certificates or licenses in order to operate your business. This is especially true for certain industries, like food or medical services.
Steps for incorporating as a C corporation
Like with S corps, you’ll need to choose a name, register the business, and get an EIN. Once you’ve secured an EIN for your C corp, you’ll have to hold an organizational meeting to draft corporate bylaws and appoint directors. You’ll also have to issue stock certificates that reflect ownership, and properly file a tax return (Form 1120) on the entity level. The IRS website provides more information about forming a C corp.
Considerations for existing businesses looking to restructure
If you’ve already established a business, you can still change its structure. Here are some common changes that business owners might make and how to make them happen:
- C corporation or LLC → S corporation: Ensure you meet the requirements for S corp designation. Then, fill out Form 2553 to change your status with the IRS.
- S corporation → C corporation: To become a C corp, a written statement of revocation has to be submitted to the IRS. This is not a form provided by the IRS, but instead a letter that you write to the IRS stating that you revoke the election to be taxed as an S corporation.
- S corporation → LLC: The corporation must be dissolved and a new LLC formed. Assets, contracts, and licenses may need to be transferred to the new entity.
FAQs
Is an S corporation the same as an LLC?
No. Although both of these business structures are suitable for small businesses or owner-operated businesses, and both are “pass-through” entities for tax purposes, they differ in ownership structures and taxation methods.
I’m just starting a new business in the US and I’m the sole person involved. Which business structure is best?
If you’re the sole proprietor, an S corp and a single-member LLC are both good options. An S corp offers more potential tax savings, whereas a single-member LLC is simpler to set up and run.
Should my startup be an S corp or a C corp?
This depends. If you’re planning to go public or raise venture capital, a C corp is generally the better choice. However, if you’re going to be running a small business and want to avoid double taxation, an S corp may be more appropriate. Bear in mind that there are restrictions on who can own shares, as well as other eligibility rules.