There are two types of business entities: C-Corps and S-Corps. Each has its pros and cons, so it is important to know the differences between them before deciding which one is best for you.
Here are some key differences between C-Corps (S-Corps) and C-Corps.
S-Corp Vs. C-Corp. The Basics
An S-Corp, a special type of business entity, offers tax benefits that are not available to other businesses. An S-Corp is a special type of business entity that meets certain criteria set forth by the IRS.
C-Corp is the most common type of corporation that the U.S. tax code recognizes. Although it is more complicated than an LLC, C-Corp offers tax benefits that other entities do not have.
Their tax structure is the most significant difference between an S-Corp or a C-Corp. Each type of corporation works best for different business types or owners because of how they are taxed.
Before you file paperwork with your state government, you will need to decide whether you want to create an S-Corporation or a C-Corp if you are thinking of starting your own business. This important decision can be made by understanding the pros and cons of both corporate structures.
What are the key benefits and disadvantages of an S-Corp as compared to a C-Corp? Let’s take a closer glance.
The Advantages of an S-Corp
There are many benefits to forming an S-Corp for your company.
- Pass-Through Taxation
An S-Corp offers pass-through taxation, which is one of its greatest advantages. This means that profits are not subject to tax by the business, but instead, the taxes are passed on to shareholders. On their tax returns, the shareholders pay taxes on their shares of the profits.
This is a huge advantage as it prevents double taxation, which occurs when shareholders and the corporation are both taxed on the same income.
- Flexibility in Allocating Income
An S-Corp also offers flexibility when it comes to how income is distributed among shareholders. This is a great way to reduce your tax burden by allocating income so that everyone pays less.
- Potential for lower Self-Employment taxes
You are responsible for self-employment taxes if you own an LLC or sole proprietorship. This includes Medicare and Social Security taxes. You may be able to reduce your self-employment taxes if you form an S-Corp.
S-Corp shareholders working for the company are employees. They must be paid wages (which are subject to self-employment tax). Shareholders who do not work for the company can avoid self-employment taxes by getting distributions rather than wages.
The Disadvantages of an S-Corp
There are many disadvantages to choosing an S-Corp as a business entity.
- Permanent Administrative Responsibility
One disadvantage to choosing an S-Corp for your business is the need to comply with IRS rules. This could include filing annual tax returns each year and keeping corporate minutes. You could lose your S-Corp status for not following the rules.
- Limited number of shareholders
The downside to an S-Corp is the limit on the number of shareholders that a company can have. The maximum number of shareholders your business can have is 100. All shareholders must be individuals and not corporations or LLCs. This restriction may make an S-Corp less suitable if you intend to raise outside capital for your startup or sell shares in your company.
The Advantages of a C-Corp
Let’s now take a look at some of the benefits that can be derived from forming a C-Corp to represent your business.
- Double taxation may not be a major concern
An S-Corp offers many advantages, including the ability to avoid double taxation. Double taxation isn’t likely to be a problem if your business does not make a profit in its first years. Because losses can be used as income to offset your tax return, this can reduce or eliminate tax liability.
- No restrictions on shareholders
C-Corps can have any number of shareholders they wish, unlike an S-Corp. You can also sell shares in your company without worrying about whether they are eligible to become an S-Corp shareholder.
- some situations could offer lower taxes
A C-Corp structure may help you reduce your tax liability if your business is financially sound. C-Corp profits, before being distributed to shareholders, are subject to tax at the corporate level. You may also be able to avoid taxes if you reinvest profits in the business (at least until your shares are sold).
- Employer Benefits
A C-Corp can also offer employee benefits such as retirement plans and health insurance that are not available to sole proprietorships or LLCs. If you are looking to hire talented employees, this can be very helpful.
The Disadvantages of a C-Corp
Let’s now look at the downsides of forming a C-Corp to help your business.
- In the early years, compliance may be difficult due to widespread complications
C-Corps can be more complex than other corporate structures, and you may need to put more effort into compliance. You will need to file tax forms each year for the IRS, hold shareholder meetings, keep track of corporate minutes and pay state franchise taxes depending on where your company is located. It may be a good idea to hire an attorney or accountant to assist you with these compliance requirements in the beginning.
- Double taxation may be a concern
A C-Corp’s disadvantage is that profits are subject to both corporate and personal tax. Double taxation can result in your business losing money. Double taxation isn’t necessarily a problem if your company isn’t profitable in its first years.
- some situations could lead to higher taxes
C-Corp structures can be more tax-efficient if your business is successful and you intend to sell it. C-Corps can be subject to double taxation (at the corporate and personal levels). You may also be subject to higher taxes if your business is not profitable, but you don’t intend on selling it in the future.
- Startups that don’t intend to raise funds are not ideal
A C-Corp may not be the best option if you are looking to create a small, profitable business with low overheads that will never need outside funding. S-Corps allow for pass-through taxation, without the compliance headaches associated with C-Corps.
How Do You Choose the Right Corporate Structure for Your Business?
Here are some factors to consider if you are still unsure whether an S-Corporation or C-Corp is the right choice for your business.
- Who will be your Shareholders?
When deciding between an S-Corp or a C-Corp, one of the most important factors to consider is who your shareholders will be. You will need to create a C-Corp if you intend to sell shares of your company to outside investors, such as venture capitalists. If you do not plan to sell shares, and you are the sole owner of the company’s stock, you can choose between an S-Corp or a C-Corp.
- What are your business goals?
Consider your business goals. An S-Corp is a good option if you are looking to create a small, profitable business with low overheads that will not need outside funding. If you are looking to grow your business quickly, or eventually sell it (or go public with an initial public offer), you will need to form a C-Corp.
- How is your tax situation?
Your tax situation is another important consideration. An S-Corp is a good option if you don’t expect your business will be profitable immediately and don’t mind paying double taxes. If your business isn’t expected to be profitable immediately and you are okay paying double taxes in the future, then a C-Corp may make more sense.
- What is your exit strategy?
It’s also important to consider your exit strategy, which is how you intend on getting out of business. You will need a C-Corp if you intend to sell your business in the future. An S-Corp is a good option if you don’t plan to sell your business or just want to make some extra cash when you retire.
Bottom line: There are pros and cons to both S-Corps as well as C-Corps. The best choice for your business will depend upon your goals and needs. To ensure the best structure for your company, consult an accountant or tax advisor.
It can be expensive to start a business. After you’ve decided whether an S-Corporation is right for you, you might want to look for someone who can offer you various financing options to help you get your business started. Progressive Business Capital provides small business loans, merchant cash advances, and business lines of credit. Invoice factoring is also available. We will find a solution that suits your company’s financial needs. Phone: (800) 508-4532 Email: [email protected]