What is the Difference Between a C-Corporation and an S-Corporation?
Choosing the type of business entity for your company has many consequences for your day-to-day operations and long-term growth. Deciding between a C-corporation and S-corporation can be confusing. Even though they are both legal entitles with some similarities, there are distinct differences that can benefit some companies. Our DC fractional general counsel explains the differences between the two legal entities and why your company may benefit from choosing one legal entity instead of the other legal entity in this article.
C-Corporations are the “Default” Corporation
When you incorporate your business in DC, the default form of the company is a C-corporation. To become an S-corporation, the shareholders of the company must vote to approve filing an election with the IRS to be designated an S-corporation. S-corps and C-corps are very similar in terms of ownership, operations, governance, liability, and capital generation. The difference lies with the choice of status as an S-Corp. The main differences between the two corporations lie with flexibility of ownership and taxation.
Differences in Ownership Between an S-Corporation and a C-Corporation
C-corporations have virtually no restrictions on who can own an interest in the company. A C-Corp can divide shares into different classes of stock, thus assigning different voting rights to different classes of stock.
However, S-corporations are limited to no more than 100 shareholders. There is only one class of stock issued by an S-Corp, so all shareholders have equal voting power. Also, S-corporations must be owned by residents or citizens of the United States. Furthermore, Insurance companies, banks, and other types of companies are not permitted to own shares in an S-Corp, but these restrictions do not apply to the shares of a C-corporation.
The flexibility of ownership in a C-corporation typically makes it a better business entity choice for companies that have a goal of making an IPO. However, if flexibility of ownership is not a concern, the taxation differences between the two corporations can make an S-corporation a better choice for some businesses.
Differences in Taxation Between an S-Corporation and a C-Corporation
One of the main differences between the two corporations is the ability to eliminate double taxation.
C-corporations must file corporate tax returns and pay taxes on profits at a corporate rate. Dividends paid to shareholders are then taxed again based on the shareholder’s personal income tax rate. The fact that a C-corporation is treated as a separate taxable entity by the IRS results in double taxation of profits.
“The flexibility of ownership in a C-corporation typically makes it a better business entity choice for companies that have a goal of making an IPO. ”
— Steve Thienel
Conversely, an S-corporation can be treated as a pass-through entity for tax purposes. Profits and losses are “passed through” the corporation to the shareholders. The shareholders pay income tax based on the profits they earned from the S-Corp. The S-Corp does not pay corporate income taxes on its earnings as the income tax liability is “passed through” to its shareholders.
Choosing Between an S-Corporation and a C-Corporation
Small business owners often choose S-corps to avoid double taxation. They can also use the losses during the initial years of growing a business to reduce their personal income tax liability. If they sell the business, capital gains taxes may be lower for an S-corporation than a C-corporation.
However, review all aspects related to choosing a business entity for your company rather than focus solely on tax-related benefits. There could be definite benefits, including long-term advantages, for a company to remain a C-Corporation.
Contact a DC Fractional General Counsel for More Information
If you need assistance with choosing a legal entity for your company or forming your business structure, contact Steve Thienel, DC fractional general counsel. He can help you review the various actions, weigh the pros and cons of each legal entity, and assist you in completing and filing the necessary documents to form a legal entity for your business.
