Are you starting a new business and want to venture into a corporate structure? This one might have you scratching your head and wondering if you’re making the right choices. It’s not rocket science, either, and we can help you figure it out!
Choosing between a C corporation vs S corporation is a crucial choice you can make for your business. It impacts your process optimization and how you file taxes, generate capital, and do your accounting.
In this blog, let’s review all the nitty-gritty of these two corporate structures. In the end, you’ll have a clear vision of the corporation structure your business is meant for.
Pro Tip: Whichever structure you choose, having well organized expenses is crucial. Modern solutions like Receiptor AI can help automate receipt management and expense tracking, making tax time more manageable for both S and C corporations.
What is an S Corp?
Under the US tax code, an S-corporation is a type of corporation that is allowed to pass its incomes, losses, deductions, and credits directly to shareholders without being taxed at the corporate level. However, there are some eligibility rules for who can file as an S-corporation.
Here are the four requirements you must consider before you can opt to become an S-Corp structure:
- The company must be a domestic corporation.
- The company must offer only one class of shares.
- All shareholders of the company must be US nationality holders.
- The company must limit the number of shareholders to 100.
Advantages of S Corp
- Increased credibility,
- Straightforward transfer of ownership,
- Utilizes cash-basis accounting method,
- Pass-through taxation with no federal taxes,
- Limited liability for every shareholder up to the value of their shares.
What is a C Corp?
A C Corporation is a legal business structure in the US in which the entity and shareholders are taxed separately. The Internal Revenue Service (IRS) recognizes it as the default corporate structure. It is a traditional corporate setup that provides unlimited growth options.
C Corps have no major restrictions on who can own shares and there's no limit to shareholders. That’s why this corporate structure is preferred by those companies that:
- Plan to grow quickly,
- Need a lot of capital, or
- Want to go public in the future.
They are ideal for firms that seek outside investment. Venture capitalists and institutional investors favor this type of structure because it offers more networks in stock ownership and a variety of stock options.
Advantages of C Corp
- Perpetual existence,
- Limited liability for owners,
- Well-defined legal precedents,
- Separate management and ownership,
- Separate legal identity than owners and shareholders,
- Shareholders can have any nationality and are not restricted.
Why is it important for small business owners to know the difference?
The corporate structure of your business lays the foundation for some of the most important aspects of your company. That’s why every small business owner must know what they’re getting into!
If you’re not sure why there’s so much buzz around picking the right corporate structure, here are some of those reasons:
- It defines how much tax you pay, at what level, with what method, and who pays the tax.
- It decides how you raise capital, including the type of stocks you can offer, the number of shareholders you can have as well as the eligibility of a person to become your company’s shareholder,
- It picks the accounting method for your organization between accrual and cash basis accounting.
What's the difference between S Corp and C Corp?
C Corporation vs S Corporation, how do you choose which structure is best for you? For one, you need to know how the differences impact your corporation’s financial health and operational flexibility. That’s why we’ve compiled all the key differences into a concise table for you:
| S Corp | C Corp |
| Profits are taxed at the shareholder level | Profits are taxed at both corporate and shareholder levels |
| Provides great tax savings | Offers greater choice to reinvest earnings |
| Only allows up to 100 US nationals to become shareholders | No ownership limits and can issue multiple stock classes |
| Limited ability to raise capital | Greater flexibility for raising capital |
| Simpler administration with fewer formal requirements | Formal management with strict meeting requirements, record-keeping, and financial reporting |
How do you make the choice?
The trajectory of your growth depends on the choices you make today. And if you’re not sure how to choose between C Corp vs LLC S Corp, you should consider these 4 elements:
1. Your business goals
In case your business ambitions are not to go beyond a limited and uncomplicated scale, an S Corp would be your preferred structure. However, If your business plans are to stay small and modest for a good chunk of the future, you’ll do just fine with an S Corp structure! Because this structure utilizes a cash basis of accounting and passes off taxation to shareholders, it makes doing business easier, eliminating the need for complex accounting software or a team of suited lawyers and accountants.
However, a C Corp is more your jam if your business goals are to:
- Grow aggressively,
- Securing venture capital funding,
- Go public through an IPO to raise funds from public investors,
- Have an unlimited number of shareholders with various stock options.
2. Your financial standing
If you want to avoid double taxation, an S Corp’s pass-through taxation can help you save on taxes. However, if your plan is to reinvest profits into the business, a C Corp might be better, as it allows you to keep earnings within the company without immediate tax impact.
3. Your future plans
If you anticipate needing significant capital or engaging multiple investors, a C Corporation provides more flexibility in issuing stock and attracting investors. Its ownership structure can also offer more options as your business expands. But if you don’t need to raise capital equity, you can stick to the simpler option of an S Corp structure!
4. Ask experts
Choosing the right corporate structure is never a straightforward decision; any decisions made should be after consulting legal and financial advisors.
As a small business owner, you'll benefit from consulting accountants and lawyers who can provide valuable insight into each option's tax implications, liability protection, and operational requirements.
Frequently Asked Questions
What does S stand for in S Corp?
The ‘S’ in an S Corp comes from Subchapter S of the Internal Revenue Code. This allows S Corps to be taxed under that section of the IRC, making it a pass-through organization for tax filing. The IRS allows S Corps to pass corporate income, deductions, and credit to shareholders.
What is the best state for S Corp?
Wyoming and Nevada are the best states for establishing an S corporation as they offer no state corporate tax, personal income tax, or even a franchise tax. Furthermore, both states are bustling hubs for business prosperity and offer strong asset protection benefits, so your business can benefit the most.
What does SME stand for?
SME stands for small and medium-sized enterprises, referring to businesses up to a certain size. Often, the size of these enterprises is gauged through their revenues, assets, or the number of full-time employees at a given time.
Why do investors prefer C Corps?
If you think C Corp vs LLC, and even when compared with S Corps, C Corps offers investors more flexibility when it comes to investing with multiple stock options. C corps have freely transferable shares, the ability to issue preferred shares, and the ability to issue stock options.
Final thoughts
Choosing between a C Corp, S Corp, or even an LLC requires careful consideration of your business goals and financial needs. S Corps are ideal for small businesses looking to avoid double taxation and keep their structure simple, while C Corps are better suited for larger companies with plans for aggressive growth or raising capital.
Ultimately, the decision between a C Corp vs LLC S Corp should align with your financial goals and future outlook. Keep in mind that you don’t have to lock in a structure right from the start. Many businesses begin with an LLC or S Corp and transition to a C Corp as their needs evolve!
