Ways to understand the difference between S-Corporations(S-Corp) and C-Corporations (C-Corps) and the advantages and disadvantages of each to make the right choice.
When starting a new business, one of the first issues you will have to deal with concerns the choice of business structure. For many small businesses, the two options are S- Corporations (S-Corps) and C-Corporations (C-Corps). Understanding the difference between S-Corp and C-Corp and the advantages and disadvantages of each can be confusing. Here’s a look at what you need to know before choosing between an S-Corp and a C-Corp for your business.
If you happen to be trying to build a technology startup or a large company, here are some reasons why incorporating in Delaware as a C-Corporation would be a good choice. Remember, if you have any questions or concerns about choosing between an S-Corp or C- corps, or regarding any other business issues, it’s always a good idea to consult with an expert.
WHAT IS A C-Corporation?
C- Corporations are those with a standard corporation form. They are legally owned by shareholders and limit the amount of each individual shareholder’s liability for business debt to the amount each has invested in the company. A C-Corp is formed with the filing of its incorporation documents (typically its Articles of Organization) and payment of fees in the state chosen for incorporation.
What is an S-Corporation?
An S-Corporation allows a company to pay no direct taxes on its income, instead allowing income to “pass-through” (be passed on to shareholders) and be declared on the shareholders’ personal tax returns. An S-Corp is originally formed as a C-Corp, after which the company elects to become an S- Corp.
C- or S-Corporation Choice is Critical for Small Businesses
Tax benefits are usually the determining factor in choosing the S-Corp form, particularly for small businesses’ tax and personal asset protection afforded by S-Corp status aid small businesses in securing financing during crucial early stages of growth. Choosing between C-Corp and S-Corp status can mean the difference between success or failure for a small business and, therefore, should only be made following consultation with a tax professional.
S-Corp vs C-Corp: Pros and Cons
S-Corp Pros
· Taxed as a pass-through entity. · Avoids double taxation.
· No corporate level taxation.
· Losses can be used to offset other income.
· Assets protected in the event of litigation.
S-Corp Cons
· Limitations on business type (such as financial and insurance)
· Restricted to 100 shareholders.
· All shareholders must be U.S. citizens or residents (with the possible exception of family members).
· Only one class of stock allowed. · For technology startups seeking venture capital, venture capitalists dislike the S Corporation structure due to limitations on the number of shareholders and the restriction for only one class of stock.
C-Corp Pros
· Allowed for any type of business.
· More growth available since there is no restriction on the number of shareholders.
· Allows investments by non-U.S. citizens. · Multiple classes of stock allowed which also allow dividing up voting rights.
· Assets protected in the event of litigation.
C-Corp Cons
· Income is double-taxed (i.e., paid by both corporation and shareholders).
· Shareholders share in the income and pay taxes but do not share in losses.
Similarities between S-Corporations and C-Corporations:
There are 4 main similarities between S-Corporations and C-Corporations:
1. Liability protection for owners. For both types, there is no liability beyond the amount invested for debts of business.
2. Strict corporate structure. Corporations have shareholders, directors, and officers. Shareholders own the company and elect the board of directors. Directors oversee larger corporate issues such as corporate goals and decision making and elect officers. Officers are in charge of day-to-day decisions within the business.
3. Corporate documents and compliance with the state. Both corporations file certain incorporation documents, typically Articles of Incorporation or Certificates of Incorporation, and have obligations to issue stock, creating and maintaining bylaws, organizing and taking meeting minutes of shareholder and director meetings, filing annual reports, and paying annual fees.
4. Separate Entities. Both types of corporations create separate legal entities in the state with “unlimited life” which continue to exist after the death of the owners.