Determining the best corporate structure for your new business can seem daunting. You may not know where to start in determining what's best for your business. Some business owners create limited liability companies, or LLCs. Others find that their business works better as an S Corporation or a C Corporation.
This article will explain the basic differences between an S-Corp and a C-Corp and the pros and cons of each type of corporate structure. While S-Corps and C-Corps are very similar, there are some important differences, particularly when it comes to taxation.
If you're considering which corporate form is best for you, contact the experienced corporate attorneys at Newburn Law today. We can discuss your situation and goals for your business to help you decide which corporate structure best meets your needs.
What Are S-Corps and C-Corps?
Individuals can run their businesses in various ways — including as a single proprietor, a partnership, a limited liability company, or a corporation. A corporation is a kind of business entity that's created by filing Articles of Incorporation or a Certificate of Incorporation in the state where the business is formed.
Corporations are subject to certain legal requirements that other entities are not subject to. Some of these legal requirements include, but are not limited to:
- Following certain corporate formalities;
- Classifying stock options;
- Restrictions based on the company's charter; and
- Tax implications.
A corporation's owners are referred to as shareholders or stockholders, and the corporation's officers and directors manage the corporation's business operations.
One of the main elements of filing your business as a corporation is determining the company's tax status. There are two main options for corporations:
- S-Corps; and
What are the shared elements of S-Corps and C-Corps?
S-Corps are C-Corps are named from certain parts of the Internal Revenue Code and are two types of corporations in the United States. Both S-Corps and C-Corps are incorporated in the same way, and they both issue stocks and maintain bylaws. They also share the common feature of protecting their owners from personal liability for the business's debts or legal obligations.
For example, if the company were sued and had to pay out money for the lawsuit, owners of the S-Corp or C-Corp would most likely not have to pay out of their own pockets for the company's financial responsibilities. This is what's known as the corporate shield, and it generally protects owners from individual liability, although there are some exceptions to this.
How is an S-Corp Different from a C-Corp?
Although S-Corps and C-Corps are similar in their structures, they have important differences.
A C-Corp is the default corporate form that the IRS recognizes when a corporation is formed. In other words, when you go to register your corporation with your state, it will automatically be registered as a C-Corp. C-Corps file their own corporate tax returns, and profits and losses remain in the company. Most major corporations in the United States are organized as C-Corps. There is no limit to the number of shareholders or to the classes of stock allowed in a C-Corp.
In contrast to a C-Corp, an S-Corp is a corporation that must meet the following requirements of the Internal Revenue Servicehttps://www.irs.gov/businesses/small-businesses-self-employed/s-corporations:
- It is a domestic corporation;
- It has only allowable shareholders (including individuals, certain trusts, and estates);
- It has no more than 100 shareholders;
- It has only one class of stock; and
- It is not otherwise ineligible corporation (such as certain financial institutions, insurance companies, etc.)
What Are the Main Differences Between a C-Corp and an S-Corp?
The primary differences between a C-Corp and an S-Corp are in how they're formed, how they're taxed, and how they can be owned.
C-Corps are considered the default corporate structure for businesses, so your business will automatically be designated as a C-Corp when you register the corporation in your state. To set up your business as an S-Corp, you must file a specific form.
C-Corps are essentially taxed twice. The business must pay corporate income tax, and the shareholders are required to pay income tax on their income from dividends. By contrast, S-Corps have no corporate income tax. Instead, the business's shareholders report income and losses on their personal tax returns. Taxes are calculated using the owner's income tax rate based on the ownership share in the company. Because of this tax structure, S-Corps are referred to as “pass-through entities.”
C-Corps can have an unlimited number of owners, and anyone can be an owner. S-Corps may have no more than 100 shareholders, and the shareholders must be U.S. citizens.
What Are the Pros and Cons of Setting up Your Business As an S-Corp?
The pros of setting up your business as an S-Corp include:
- Income is only taxed at the shareholder level
- S-Corps may use the cash method of accounting
The cons of setting up your business as an S-Corp include:
- Potentially higher formation and maintenance expenses
- Less flexibility in allocating loss and income
- Potentially more scrutiny from the IRS to ensure compliance with restrictions
What Are the Pros and Cons of Setting up Your Business As a C-Corp?
The pros of setting up your business as a C-Corp include:
- Less paperwork to file when setting up because C-Corps are the default status for corporations
- No ownership restrictions or limits on the classes of stocks
- The ability to raise equity financing more easily than S-Corps
The cons of setting up your business as a C-Corp include:
- Double taxation, as the corporate entity's revenue is taxed first, and then shareholders are taxed again on their personal tax returns
- No write-offs from company losses or expenses on the owner's personal tax returns
- Corporate structure is more rigid than some other business entities and can be more expensive and time-consuming to comply with corporate formalities
What Type of Businesses Are Best Suited for Each Corporate Form?
Generally, S-Corps are the best option when you're seeking limited ownership since they're limited to 100 shareholders. On the other hand, if you want to obtain investors for funding, or if you want to eventually sell the business, you likely will want to set it up as a C-Corp. The C-Corp structure is good for businesses that want to grow and want to eventually be purchased by larger businesses.
How to Create Your Business As a C-Corp or S-Corp
Both C-Corps and S-Corps are organized under the law of the state in which the business is set up, and the laws vary from state to state for their formation. The typical procedure is to register the entity through the Secretary of State website for the state where you're setting up the corporation, and the state issues a certificate upon formation. All states pay a fee to incorporate.
In Colorado, you must take the following steps to register your business as a C-Corp or an S-Corp:
- Choose a name for business. Your business's name can't be the same name as any other Colorado-registered business entities.
- Appoint a Registered Agent. You must appoint a registered agent authorized to receive service of process and other legal notices on the company's behalf.
- Choose Directors or Managers. The designated directors or managers will make decisions for the company.
- File Articles of Incorporation/Organization with the Colorado Secretary of State. The Articles of Incorporation must include the business name and address, the registered agent's name, each incorporator of the business, and the initial number of shares.
- File a separate Form 2553 if you want the business to be an S-Corp.
Steps to Change from One Form to Another
If you already have your business entity set up and you're thinking about changing it to another form, you should probably talk to a professional first to find out your options. Changing from a C-Corp to an S-Corp is relatively simple, as you simply file the IRS Form 2553 indicating the S-Corp designation. All shareholders must sign and form, and it must be filed no later than two months and fifteen days from the beginning of the tax year. Before considering changing from a C-Corp to an S-Corp, consider the tax implications. You must also make sure that your corporation meets the requirements for becoming an S-Corp, including the capitalization requirement, shareholder requirements, etc.
Sometimes businesses change so they no longer meet the requirements for an S-Corp. In that event, some business owners may elect to change from an S-Corp to a C-Corp. The IRS doesn't have a specific form for that change. Rather, if you want to change from an S-Corp to a C-Corp, you must file a written statement with the IRS, and you must receive written consent from more than 50% of the corporation's shareholders.
Before you make any changes to your corporate form, you should talk to a tax professional about the tax and other implications of changing your business's corporate form. Our attorneys at Newburn Law can help you decide whether changing the corporate form of your business makes sense for you.
Contact Us Today to Find out Your Options
If you're wondering what type of corporate structure your business needs, contact the experienced attorneys at Newburn Law today. We can help you better understand each corporate structure and help you determine which structure is right for your business.
We can guide you every step of the way, through selecting a name for your business, to registering your Articles of Incorporation, to helping you with setting up your corporate structure so that you meet the corporate formality requirements for your business.
Contact us today for a free consultation.