Starting a business is a big decision and one that will doubtlessly change the course of your life. One fundamental decision you have to make at the beginning is what type of business your new enterprise will be: a sole proprietorship, a partnership, an LLC, or a corporation. Now, if you choose to incorporate, there is another question: are you going to be a C Corp or an S Corp? What’s the difference? Let’s find out.
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The first thing to know about how these two structures differ is that there is a default case for corporations–C Corps. If you wanted to make an S Corp, you should fill out the IRS Form 2553. Now, you don’t necessarily need to decide right away: After incorporating, you can go up to 75 days as a C Corp before filing as an S Corp. However, at the beginning of the year you may change to an S Corp, though you must file prior to March 15th. Though you should be aware: once this decision is made, you cannot change your election for 60 months.
An IRS Form 2553 must be completed in order to form an S Corp.
Both C Corps and S Corps are corporations, which state laws treat the same, so the difference comes from sections of IRS codes which govern how corporations are taxed. Both have similar requirements for adopting bylaws, issuing stock shares, and even holding meetings for shareholders and directors. Really, the biggest difference between C Corps and S Corps is how they pay taxes and how they are structured.
In essence, C Corp and S Corps are subject to different rules regarding how they are taxed. C Corps are subject to what is known as double taxation. This means that the corporation pays federal income tax on its net income and shareholders pay federal income tax on any dividends they receive. In contrast, S Corps are known as pass-through entities. This means that the corporation itself doesn’t pay taxes–only the owners do, they only have to pay their income tax at their individual rates.
So, that settles it, right? S Corps pay less in taxes, so everyone should set up their LLC as an S Corp, right? Not so fast. See, if your company is an S Corp and your company has losses in the tax year, those losses flow through to the owners. C Corps can’t pass losses onto the owners. Additionally, C Corp taxes are a flat 21%, but individual income tax rates can climb as high as 37%. However, as of 2017, owners of S Corps may be able to deduct 20% of business income from their individual tax returns. C Corps cannot do this.
Finally, there are differences in ownership rules. C Corps have no ownership restrictions: they can have as many owners as they’d like and anyone can be an owner. S Corps are a bit more limited, though: they can have a cap at 100 shareholders and all owners must be US citizens.
So, what should you choose? The decision to be a C Corp or an S Corp is a big one, one that has significant effects on the business. There is no end-all solution for business owners, because they have a lot to consider. If you find yourself in need of a team of tax and accounting experts to help you along your way, we’re your partners.