Self-incorporation is not a new concept. There are many business owners that continue to protect their personal assets by forming a company. In addition, there are many business owners that also elect to form subchapter S corporations or C corporations as an alternative to operating as sole proprietors or general partnerships. This article details the differences between S corporations and C corporations in terms of liability, taxes, and operational requirements.
What is a C Corporation?
A C Corporation is a business entity that has been incorporated by filing Articles of Incorporation with a state government. It is a separate legal entity from its owners, meaning that owners of a C Corporation are not liable for the business’s debts, taxes, or other liabilities. C corporations are also subject to corporate income taxes and are required to file a corporate tax return and pay estimated taxes throughout the year. C corporations are typically large companies, but there are some small businesses that would be more appropriately structured as C Corporations. For example, a business that will be issuing significant amounts of debt (e.g. a large construction project) may choose a C Corporation structure to protect the debt-holders from the personal liability of business owners.
What is an S Corporation?
An S Corporation is a business entity that has been incorporated by filing Articles of Incorporation with a state government. Owners of an S Corporation are called “shareholders,” and the business itself is often referred to as a “corporation” or “company.” S corporations are pass-through entities, meaning that business profits, losses, and deductions flow directly to the individual owners’ tax returns. This means that S Corps are not subject to corporate income taxes. S corporations also protect owners from personal liability for business debts, taxes, and other liabilities. Unlike C Corporations, there are no limits on how many shareholders an S Corporation can have. An S Corporation is often a good choice for a small business that wants to limit exposure to personal liability and minimize taxes.
Differences between an S Corp and C Corp
Owners of S corporations are called “shareholders,” and the business itself is referred to as a “corporation” or “company.” Owners of C corporations are called “stockholders,” and the business itself is referred to as a “corporation” or “company.” C corporations are subject to corporate income taxes and S corporations are pass-through entities. C corporations are typically large companies and S corporations are often used by small businesses. C corporations can have no more than 100 shareholders, while S corporations can have an unlimited number of shareholders. C corporations are governed by state law and S corporations are governed by federal and state law.
Which Is Better for Small Businesses?
There is no definitive answer to this question. All businesses have different facts and circumstances, and each business owner must decide what works best for their business. C Corporations are typically recommended for businesses that issue significant amounts of debt, have significant profit margins, or need a strong barrier between the owners and the business itself. C Corporations are also typically recommended for businesses that expect to grow to significant size. S Corporations are typically recommended for businesses that have low levels of debt, have relatively small profit margins, or want to minimize taxes and administrative burdens. S Corporations are also typically recommended for businesses that expect to stay at a small scale, or for businesses where two or more owners are working together to operate the business.
Downsides to forming a C Corporation
C Corporations are relatively complex to set up and operate. There are many state and federal rules and regulations that must be followed to protect owners from personal liability for the business. C Corporations are subject to corporate income taxes at both the state and federal level. This means that C Corporations are at an immediate disadvantage relative to pass-through entities like S Corporations. C Corporations also have many ongoing administrative requirements. The business must file an annual report, keep minutes of board meetings, and maintain records of corporate actions.
Downsides to forming an S Corporation
S Corporations must file a special election to be treated as an S Corporation each year. If the election is not timely made, the business will be treated as a C Corporation. C Corporations are typically recommended for businesses that issue significant amounts of debt, have significant profit margins, or need a strong barrier between the owners and the business itself. S Corporations are typically recommended for businesses that have low levels of debt, have relatively small profit margins, or want to minimize taxes and administrative burdens.
Key takeaways
S Corporations are pass-through entities, whereas C Corporations are subject to corporate income taxes. C Corporations are typically large companies, whereas S Corporations are often used by small businesses. C Corporations can have no more than 100 shareholders, whereas S Corporations can have an unlimited number of shareholders. C Corporations are governed by state law and S Corporations are governed by federal and state law. C Corporations are typically recommended for businesses that issue significant amounts of debt, have significant profit margins, or need a strong barrier between the owners and the business itself. C Corporations are also typically recommended for businesses that expect to grow to significant size. S Corporations are typically recommended for businesses that have low levels of debt, have relatively small profit margins, or want to minimize taxes and administrative burdens. Finally, you should not make a decision to form an S Corporation or C Corporation without consulting a tax advisor and an attorney.