When you want to incorporate a business, there are two different structures from which to choose: an S-corporation or a C-corporation. This choice is often based on the ideal tax structure for the company. When operating under the S-corp structure, then it is treated as a pass-through entity. That means the profits of the business (and the losses) are reported on the income of the business owner.
There are no corporate income tax concerns with a S-corporation in the United States.
When a business operates as a C-corp, then the profits are first taxed at the corporate level. Then the owner’s personal income tax returns are taxed too, based on if the income is distributed to the shareholders of the corporation as dividends.
Because both corporation structures require similar compliance and documentation obligations, understanding the additional benefits of the S-corp vs. the C-corp will help you decide which option is right for your needs.
List of the Pros of an S Corp vs. a C Corp
1. The S-Corp profits are only taxed once at the federal level.
The biggest advantage of choosing the S-corp over the C-corp is the avoidance of double taxation on profits. When a company incorporates as a C-corporation, the profits are first taxed at the corporate level through IRS Form 1120. Then the money is taxed again on the owner’s personal income tax returns if they distribute income to shareholders as a dividend.
The only ways to avoid this issue as a C-corp is to operate at a loss or reinvest profits back into the business instead of paying a dividend. With the S-corp structure, all shareholders report their share of income or loss on their tax return only. That means you pay at whatever your personal income bracket happens to be instead of the current corporate rate.
2. S-Corp entities have a special deduction they can take.
Beginning with the 2018 tax year, the Tax Cuts and Jobs Act passed by Congress and signed into law by President Donald Trump allow pass-through entities like an S-corporation to deduct 20% of their business income on their personal tax return. At the time of this writing, this deduction is not set to expire until 2025. That means a business owner with $100,000 of S-corp profit to report on their personal tax return can eliminate $20,000 from the top, effectively giving them that cash tax-free.
Any pass-through entity, including partnerships, LLCs, and sole proprietors qualify for this potential advantage too. C-corporations do not qualify at all for this advantage.
3. Personal assets are not at stake in the S-corporation structure.
Because the corporation is treated as its own structure, the personal assets of the S-corporation owner are not at risk like they are with a sole proprietor or a partnership. C-corporations offer this benefit too. The company assets are kept separate from personal assets.
There are times when this advantage does go away. If owners contribute significantly to the income of their company by mixing personal and business funds, then this is called “piercing the corporate veil.” The courts could decide in such a circumstance that personal assets should be unprotected. C-corporations carry this risk too, though sometimes at a lesser level.
4. There is better privacy protection with an S-corporation.
C-corporations are public businesses which create records that investors can review at their convenience. Although there are some privacy protections in place with this structure, the S-corporation is a better option if you’re trying to limit how much information is in the public view.
This benefit often applies to the salaries being paid to officers and owners. Because of the income-splitting potential of this business type, you can take a smaller salary (based on income rules set by the IRS), then take the remainder of the profit as a distribution. This structure limits public awareness of what some active shareholders earn, which provides some level of information protection.
5. There are fewer administrative requirements.
You’ll find that the paperwork requirements to follow rules, laws, and regulations are similar when comparing S-corps vs. C-corps. When all of these responsibilities are compared, however, the S-corporation does have a few advantages to look at. The profit-sharing paperwork is the biggest differential. Because of the pass-through nature of the S-corporation, much of the work falls onto each person instead of coming through the corporation itself.
You’ll still face the requirements to hold formal meetings, release notes from the Board of Directors, and distribute financial information. What you won’t face are the corporate tax filings.
6. S-corporations are affordable to start.
Most companies that decide to form S-corporations do so because they plan to provide a specific service to their community. It’s a great option for a business which requires more formality than an LLC, but it also wishes to keep its ownership circle tight. You don’t have the same significant equipment purchases with this operation compared to a C-corp when starting operations. You can earn a sizable profit without a lot of expense or effort. There are usually smaller start-up costs associated with this structure compared to the C-corp too.
7. Owners can write off their start-up losses with an S-corporation.
One of the biggest advantages of forming an S-corporation is that you’re able to write-off your start-up losses when you’re a shareholder. Thanks to the pass-through nature of this entity, you gain access to your share of the losses like you do with the profits. That doesn’t change your salary status either. Those losses can help you keep your overall tax liabilities lower, with significant losses carried over to different tax years to keep offsetting future profits earned.
When President Donald Trump reported an almost $1 billion loss to the IRS in the 1990s, he had the potential to carry-over that amount for over a decade to limit his overall liability. Most shareholders see this advantage on a smaller scale, of course.
8. You don’t need to have 100 shareholders with the business.
Venture capitalists and other investors don’t like the idea of dealing with up to 100 people whenever a decision must be made. Even though the equity share is low in that situation, every person has an equal voice in the final decisions made. That’s why the C-corporation status is preferred for most.
Just because you’re permitted 100 shareholders as an S-corporation doesn’t mean you must have that many. Creating an agreement which limits the number of owners involved with your articles of incorporation can offer some angels and VCs more confidence in your corporate structure.
9. There are fewer publication standards to follow.
Other business types, including the C-corporation in some communities, must publish changes in structure, assets acquired, or planned developments in local periodicals to create public awareness of what they are doing. New York State requires potential LLC owners, for example, to publish a formal notice of formation that can last for several weeks. The structure of the S-corp allows you to get around that issue without the same delays.
Once you file for your status, you begin operations once you secure the correct documentation. Most companies can begin serving their customers faster and more efficiently because of this change in structure.
List of the Cons of an S Corp vs. a Corp
1. It is more challenging to incorporate as an S-corp than as a C-corp.
The United States deems that the C-corporation structure is the default incorporation to use when forming a business. When you file the articles of incorporation with your local Secretary of State, this is the company it becomes. You must file IRS Form 2553 as part of your initial paperwork to ensure you become an S-corp for federal tax purposes. Some states require you to fill out additional documentation to be treated this way at their level too.
As with any business incorporation, you may need to appoint a registered agent, create bylaws for the company, and apply for specific licenses or certifications to conduct business within the state. These costs are similar for both structures, but it may be more expensive when compared to partnerships or sole proprietors.
2. The C-Corporation tax rate is a flat, predictable fee.
The Tax Cuts and Jobs Act might not offer the C-corp a deduction of business income like it does for the S-corporation, but it does offer a significant drop in the tax rate. Companies who operate as C-corporations will see their tax rate decline from 35% to 21% beginning with their 2018 tax year filing.
With the S-corp structure, the tax rate is based on the activity of the shareholder in the daily operations of the corporation. Wages are taxed in three different ways.
• There is a 15.3% tax on the first $117,000 earned.
• A 2.9% tax applies on the next $83,000 earned.
• Then a 3.8% tax applies on income over $200,000.
Wages are taxed with an S-corp, but its profit distribution is not. Passive shareholders are subject to the Net Investment Income Tax instead, which is a higher marginal tax for most individuals when compared to active shareholders.
3. There are income caps in place for the 20% deduction.
The tax law governing the 2018 filing season allows pass-through entities earning $315,000 for married joint filers or $157,500 for single filers to take advantage of the 20% deduction off the top for income. There are limits to this deduction based on the type of business your S-corp happens to be, so doctors and lawyers may see limited tax benefits when compared to C-corporation structures. Limits to what employees are paid in wages apply too. If you earn more than the figures above, you may lose out on the tax savings compared to the permanent cuts offered to the C-corp.
4. S-corporations have a difference in the ownership structure.
S-corporations can have up to 100 shareholders associated with the business. Each shareholder must be either a resident alien or a U.S. citizen. They are limited to one class of stock too, which means there is only one type of shareholder within the structure. Because there is no hierarchy within the corporation, with no differences between shareholders, the fundraising goals of the company are harder to achieve.
C-corporations have no restrictions on ownership at the time of writing. You’re permitted an unlimited number of shareholders within the company, along with different classes too. That’s when angels and venture capitalists prefer this option, as it gives them the opportunity to hold preferred stock.
5. S-corporations cannot deduct their fringe benefits.
The current structure of the C-corporation allows it to deduce the cost of any fringe benefits which are given to employees. That includes things like their health insurance or disability. The shareholders of the C-corp don’t pay takes on these benefits either, assuming that a minimum of 70% of the company receives the same fringe benefits.
The S-corporation does not get this benefit at all. Anything treated as income distributed to the shareholder is subject to the tax rates listed. Since both corporation types don’t carry the self-employment tax with them, an organization which sees distributions through fringe benefits frequently will find the C-corp structure beneficial when compared to the S-corp structure.
6. The S-corporation status can be terminated by the IRS.
Because of the potential tax advantages of being an S-corporation, taxing authorities scrutinize this structure heavily compared to the default C-corporation status. You’ll find that if you make a mistake with your administrative requirements, even if you just missing a filing deadline, your S-corp status can be terminated. This scenario often happens when you accidentally go over 100 shares too. When this situation occurs, your company is then taxed as a C-corp, which means you must file the corporate tax return by the appropriate deadline.
If this situation were to occur, the IRS may charge back taxes for up to 3 years to compensate for earlier violations of the S-corp status. Companies must then wait at least 5 years to regain their status after the forced conversion o a C-corporation.
7. There are salary requirements with an S-corporation to follow.
The IRS requires that all owners and officers in an S-corporation earn a salary, even if the company isn’t turning a profit for the year. That makes it challenging for some organizations to make their payroll, especially with the pass-through nature of the business. A “reasonable salary” is part of that expectation, so compensation must be offered based on the skills required for the position. This requirement is based on what the free market pricing is for that salary.
These employees and owners who have more than 2% of the shares of the company in questions cannot get the tax-free benefits which others with a lower share can often receive.
8. Shares can be seized and sold in court proceedings.
The IRS has the right to pursue tax payments from anyone who has ownership in the company. If the organization cannot pay its tax obligations, with back taxes creating a liability, then the shareholders can be pursued for this payment. The tax liabilities of an S-corporation can become shareholder liabilities. The shares of this company can be seized, then sold, to pay this obligation.
A C-corporation faces this risk as well, but it comes with several more safeguards in place. There are usually hundreds, if not thousands or more, individual stockholders with a publicly-traded company. This causes the tax pursuit to look at the business itself instead of each individual. Since S-corps have 100 shareholders at maximum, it is easier to pursue individuals with this disadvantage.
9. S-corporations must file their taxes earlier.
The S-corporation must file its tax returns by March 15 (or a designated date) each year. The only time this deadline shifts is if the date falls on a non-business day, which then makes it the first business day after the 15th. You can file for an automatic six-month extension if needed to meet your obligations. This tax day is the same that is required of general partnerships.
C-corporations have an extra month to prepare their taxes. The C-corp files on the same day as the individual, trust, and estate income taxes are due.
Both corporations must also follow the deadline rule if they operate on a fiscal year instead of a calendar year. Under the fiscal year structure, the deadline for an S-corp is the 15th day of the third month following their year, while for the C-corp it is the 15th day of the fourth month following the fiscal year.
10. C-corporations work better as an estate planning vehicle.
The S-corporation keeps control in the hands of the stockholders. Owners can hand down their shares to their children, but since each share is an equal part of the whole without additional status, that means just 1% could be handed down – even if the CEO is the primary founder of the business. Planned gifting scenarios work better with a C-corporation because majority control of the business can be shifted from parents to children. Once the kids receive ownership of the stocks involved, then they get to take over full control of the company.
11. Appreciating investments are challenging to hold with an S-corporation.
If you’re thinking about holding onto an appreciating investment within a corporate structure, then a limited partnership or an LLC might be a better option than even an S-corp or a C-corp. That’s because the capital gain on the sale of assets with the pass-through stipulations are different with the S-corporation structure. Owners will face higher taxes with the S-corp compared to the LP or LLC, which means you’ll lose more of the appreciation value after the sale occurs.
12. You don’t need to earn money with an S-corporation to be taxed.
When you’re a shareholder in an S-corporation, then you may not receive any direct money from the company that improves your personal income. From the perspective of the IRS, that doesn’t matter. If the organization acquires income in any way, then your share of that profit is reported at the state and federal level. You’re responsible for that tax, even though no cash traded hands. That means your paper profits can turn into real losses when it comes time to hand in your tax return for the year.
13. C-corporations do not require the self-employment tax.
Under the structure of the C-corporation, your earnings go through the capital gains process for dividends, then the income tax brackets for personal wages. Although owners experience double taxation sometimes, they’re not stuck with the self-employment tax like some S-corporation shareholders.
With an S-corp, only the dividends are not subject to the self-employment tax in the United States. Further limitations on the salary demands restrict this issue even further. At the end of the day, however, stockholders don’t face the same 15.3% scenario that shareholders in the S-corp face.
These S-corp vs. C-corp pros and cons apply themselves unequally based on the unique needs of each business. Where you choose to incorporate, the type of business you conduct, and the amount of money you earn all play influential roles in determining which option is the best one to meet your needs. Before filing your articles of incorporation, consult with an attorney familiar with the advantages and disadvantages of each structure to determine which option will serve your financial needs the best.
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