S Corp vs. C Corp Tax Advantages

As a business owner, you have a lot of important decisions to make. One of these decisions is whether you want to operate your business as an S corporation (S corp) or a C corporation (C corp).

Choosing between an S corp vs. C corp will impact your business, including its tax advantages and tax status. In this guide, we will explore the differences between these two business structures and help you decide the best fit for your business needs.

What Is an S Corp?

An S corp is a specific type of corporation with certain features and benefits compared to other business structures.

The main feature of an S corp is that it allows its owners to report their share of the company’s profits on their tax returns rather than paying corporate taxes at the entity level.

This can have significant tax advantages for businesses, especially regarding reducing self-employment taxes. But unlike C corps, there’s only one class of stock in an S corp.

An S corp is also subject to fewer regulations than a C corporation and typically has fewer filing and reporting requirements with the IRS. This makes an S corp ideal for small business owners who want to avoid dealing with complex tax filings and prefer less bureaucracy.

As a pass-through entity, the S corp is best suited for businesses with a smaller number of shareholders (typically less than 100).

What Is a C Corp?

A C corporation is another type of business structure with distinct features and benefits compared to other types. For example, the C corp business structure allows owners to raise capital by selling stock.

In addition, C corporations have fewer restrictions and regulations than S corporations concerning how much profit they can distribute to shareholders in a given year. As such, C corps are an attractive option for businesses looking to quickly expand and raise large amounts of capital from investors.

However, C corporations may be subject to higher tax rates (corporate tax rates) than S corps. This can make it more difficult for businesses to retain profits and may force them to make difficult financial choices to avoid paying large sums of money in taxes.

Ultimately, there is no right or wrong answer when choosing between an S corp and a C corp. Both business structures offer unique advantages depending on your specific business needs and goals. So let’s look at some more particular advantages and disadvantages to help you decide the best option for your business.

C Corp vs. S Corp: Pros and Cons

Pros of an S Corp

Lower Taxes: As we mentioned above, one significant advantage of choosing an S corp is that its owners can report their share of profits on their personal income tax returns rather than paying corporate taxes at the entity level. This reduces the overall tax liability for your business and can help you retain more of your profits to reinvest them in your business.

Fewer Regulations: S corps generally face fewer regulations than C corps regarding day-to-day operations. This means that businesses with an S-corp structure have greater flexibility in terms of running their operations and making important decisions.

Ease of Setup: Setting up an S corp is a relatively simple process, especially compared to setting up other types of corporations. Because there are fewer requirements for forming and operating an S corp, you’ll be able to get your business up and running in no time.

Tax Savings for Shareholders: As a pass-through entity, S corps offers significant tax savings for owners in the form of self-employment taxes. This means that shareholders will be able to keep more of their profits from personal income taxes—which can add to huge savings over time.

Cons of an S Corp

Limited Shareholder Count: S corps are typically limited to no more than 100 shareholders. If your business has many owners or employees, this may not be the best option for you.

Restrictions on Distribution of Profits: In order to maintain their S-corp status, businesses must follow strict rules about how they can distribute profits among owners and shareholders. This can make it difficult to quickly reinvest profits in your business or retain them for future use.

Higher Start-Up Costs: Compared to other types of corporations, setting up an S corp typically requires higher start-up fees and registration costs. So, if you’re a small business owner on a tight budget, you may want to consider another option.

One Class of Stock: S corps can only issue one class of stock; multiple share classes are not allowed. This can make it more challenging to raise money from investors or attract other types of funding for your company.

Double Taxation: S corps are subject to double taxation. All money the business earns is taxed, and dividends paid to shareholders must also be taxed at their individual income tax rate. So while S corps can benefit from some of the same tax breaks that C corps enjoy, they’ll have fewer opportunities to avoid taxes altogether in comparison.

Pros of a C Corp

Easier to Raise Capital: One of the most significant advantages of choosing a C corp is that it can be used as a fundraising tool for your business. Because C corporations can sell stock and raise capital through the sale of shares, they’re an attractive option for companies looking to expand quickly.

Tax Deductions: C corps can take advantage of various tax deductions for items such as business expenses, employee salaries and benefits, and other costs related to running your business. This can help ease the burden of paying corporate taxes on your profits.

Higher Profit Retention: Compared to S corps, businesses with a C corp structure have more control over how they distribute profits among owners and shareholders. This gives businesses more freedom to retain earnings for future use or reinvest them in the business.

Less Recordkeeping: C corps require less recordkeeping since they’re not subject to strict IRS requirements regarding their operations. In most cases, C corp tax returns are more straightforward to file each year than corporate income tax returns for other corporations.

Cons of a C Corp

Potential Double Taxation: The main issue with C corporations is the potential to pay taxes twice on shareholder distributions, such as dividends. C corps must pay taxes on earnings on the corporate level, and then shareholders must pay taxes again on any capital distributions. However, savvy business owners who do not plan to pay dividends can avoid double taxation to themselves by increasing their compensation, which is an above-the-line deduction. Nevertheless, any retained earnings that stay in business will be subjected to taxes at the end of the year.

Additional Administrative Requirements: C corporations are subject to additional rules and regulations that affect daily operations. And as such, businesses with a C corp structure have more paperwork to handle on an ongoing basis.

Compliance Costs: In addition to more administrative requirements, C corps are also subject to higher compliance costs than other corporations. Businesses with a C corp structure will have to pay additional fees related to franchise taxes, licensing and membership dues, and annual reports.

Limited Tax Benefits: While S corps provide some tax benefits for owners, C corps are typically subject to higher taxes on their profits. And as such, businesses with a C corp structure may see fewer savings in terms of corporate taxes than some other types of corporations.

The pros and cons of S corps vs. C corps will depend on your business needs and goals. So, if you’re looking for a way to raise capital and grow your business quickly, then a C corp is often the right choice.

But if you’re interested in maintaining more control over owner profits or want to keep things simple, an S corp may be better suited to your needs. In either case, it’s essential to weigh all of the pros and cons of each type of corporation before making your final decision.

C Corp vs. S Corp: What’s the Difference?

So far, we’ve looked at the pros and cons of each business structure. Now, let’s compare the differences between a C corp and an S corp.

Here, we’ll break down some key factors important to businesses and determine which structure has the better benefits.

Ownership Options

C corps and S corps can offer different ownership structures. However, only S corps can allow shareholders to defer their tax on the gains of their shares until they sell them. Additionally, S corp owners may enjoy a lower self-employment tax rate than that of a C corp.

Qualified Business Income Deduction

The new QBI deduction is a tax benefit for individual taxpayers, allowing for a 20% deduction on qualified business income. However, this can only be claimed by pass-through entities such as S corps and LLCs (limited liability companies), but not C corps.

Limited Liability Protections

S corps and C corps offer limited liability protections to their shareholders and board of directors. However, while S corps offer protection to non-employee shareholders, C corps only provide liability protections to their employee shareholders.

Pass-through vs. Corporate Taxation

For most businesses, it is beneficial to be taxed as a pass-through entity like an S corp rather than a corporate entity like a C corp. This is because S corporations are not subject to corporate taxes and can pass their income on to individual shareholders, who will then be taxed at their income tax rate. In contrast, C corps must pay a corporate tax on their net income before it is passed to shareholders as dividends.

Profit Distribution

If you want more control over how your business distributes its profits, an S corp may be the better choice. With an S corp, you can decide how much of your company’s profit to pass along to shareholders as salary and how much to retain in the business. In contrast, with a C corp, dividends are distributed with double taxation unless other arrangements are made.

Fringe Benefits

Both C corporations and S corporations can offer their employees various fringe benefits, such as health insurance and retirement plans. However, when offered by an S corp, these benefits may have other tax implications.

Paperwork

While S corps typically have more straightforward tax reporting requirements than C corps, S corps also have more restrictions and regulations. For example, S corporations need to file an information return and a tax return each year, while C corporations only need to file a single tax return.

What’s more, there is significantly more paperwork involved with an S corporation when you file articles of incorporation.

Complexity

Overall, an S corporation’s status tends to be more complex than a C corporation due to its structure and the additional regulations that come with being a pass-through entity. Therefore, if you are looking for simplicity in your business structure, choose a C corp instead.

While there are several factors to consider when comparing these two types of business structures, it is clear that an S corp has several advantages over a C corp.

Whether you are looking for tax benefits, liability protection, or control over your business’s profits, the S corp may be your best option.

However, it is essential to consider all the factors carefully and consult an accountant or legal expert before making any final decisions.

Similarities between an S Corp and a C Corp

The most considerable similarity between an S corp and a C corp is that both are subject to the same internal revenue code, meaning they have similar tax advantages.

Both types of corporations have some flexibility regarding their ability to minimize taxes. For example, both can make certain distributions that the IRS treats as wages or dividends, which can then be deducted as business expenses.

Similarly, a C corp may choose to pay out dividends to shareholders rather than wages to employees, and the IRS may treat some of these payments as returns of capital instead of taxable income.

Another area where both entities mirror one another is limited liability protection. This means that the shareholders of both types of corporations are protected from any legal actions regarding their role as owners, and they don’t have to worry about being held personally responsible for company debts.

As such, your personal assets are safe from the consequences of business decisions and legal disputes, which can be a huge relief for entrepreneurs.

Overall, company management is also similar between an S corp and a C corp. Both types of corporations are technically required to have a board of directors, which is responsible for determining the overall direction and strategy of the company.

This means that you’ll need to maintain at least one member on your board with experience in business leadership, regardless of the type you choose. But don’t worry, the number of board members is based on the number of shareholders, and in a single-member company, you can be the sole board member.

Which Is Right for You?

When trying to determine the type of business entity that is best for your company, there are a few questions you can ask yourself to help narrow down your options.

1. Do you plan to sell your company in the future? If so, consider a C corporation, as this type of business entity typically offers greater flexibility and liquidity than an S corporation.

2. Are you comfortable with having limited shareholders in your company? An S corporation is typically better suited to small, closely-held businesses with a limited number of shareholders, as it can be challenging to find investors or raise additional capital for an S corporation.

3. Are you concerned with the possibility of double taxation on your company’s profits? With a C corporation, any profits that pass through to the shareholders are subject to tax at both corporate and individual tax levels. As the owner of a C corporation, you must be aware of double taxation of your company’s profits. This can be combatted by distributing more salary and compensation to reduce net earnings.

4. Are you comfortable with facing extra scrutiny from the IRS? Because they are subject to more stringent regulations than C corporations, S corporations may face additional scrutiny from the IRS and other tax authorities, which can be a concern for business owners.

5. Are there other options that may better suit your needs? Depending on your company’s unique needs, consider other business entities, such as LLCs or partnerships. Consulting with an experienced attorney or accountant can help you determine the type of entity best for your business.

FAQs: S Corp vs. C Corp

What is the difference between an S corp and a C corp?

An S corp, also known as a “pass-through” entity, is similar to a sole proprietorship or partnership in that its profits and losses are passed through directly to your personal tax return. A C corp, on the other hand, pays taxes at the corporate level before any profits are passed to the shareholders.

What are some of the tax advantages of an S corp?

One of the key tax advantages of an S corp is that you can deduct your business losses against your other personal income, whereas a C corp cannot. Additionally, because C corps are taxed at both the corporate and individual levels, S corps often have lower overall tax rates.

Are there any other advantages of an S corp?

In addition to the tax benefits, there are other advantages of an S corp compared to a C corp. For example, shareholders in an S corp may save on self-employment taxes by taking advantage of special tax breaks, such as the ability to contribute to a Simplified Employee Pension plan.

What are some disadvantages of an S corp vs. C corp?

Although there are several benefits to an S corp, there may also be some trade-offs compared to a C corp. For example, all shareholders in an S corp are subject to the “self-employment tax,” which includes Social Security and Medicare contributions.

Additionally, while S corp shareholders can enjoy certain personal tax breaks, they may not be able to claim as many deductions as C corp owners.

How can I decide whether an S corp vs. C corp is right for my business?

The best way to decide whether an S corp or a C corp would be suitable for your business is to consider your company’s unique needs and goals. An accountant or tax professional can help you evaluate the implications of each structure to make the most informed decision.