Choosing a business structure is a big deal. The way you structure your business affects how much you pay in taxes, your personal liability for business losses, how you pay yourself from your business, and more. Sole proprietorships, partnerships, corporations (S Corp and C Corp), and LLCs (single-member and multi-member LLCs) are business structure types.
Corporations are popular business structure choices for employers. In 2012, 66% of all small employer firms were structured as corporations. Of that 66%, 44% were S corporations and 22% were C corporations. What is the difference between S Corp and C Corp?
What is the difference between S Corp and C Corp?
S corporations and C corporations are business structures that legally separate the business from the owner. Because the company is a separate legal entity, you are protected by limited liability. If the business cannot pay its debts, you are not personally liable for them.
The word corporation on its own refers to C corporations. Both S Corps and corporations have shareholders. Shareholders are owners who have a share in the corporation. They receive payments from the business’s income.
You must understand the difference between a C corporation and an S corporation to decide which is right for your business.
Fees
Forming an S or C corporation comes with mandatory fees. To be an S Corp, owners typically pay ongoing fees like annual report fees and/or franchise taxes. There is also a fee to form a C corporation.
Taxes
C corporations are subject to double taxation. This means that the business is taxed and shareholders are also taxed on their individual income.
S corporations avoid double taxation by using a pass-through tax. All profits and losses flow through the business directly to shareholders. That way, shareholders are taxed on their personal returns.
Business owner income
Knowing how to pay yourself legally from your company is an important part of being a business owner.
You must take a salary if you own a C Corp or S Corp and actively work in the company. You will receive dividends if you do not actively work in a C Corp but are a shareholder. If you do not actively work in an S Corp but are a shareholder, you will receive distributions.
Unlike C Corp owners, S Corp owners can receive both salaries and distributions. Salaries and distributions are taxed differently. Employment taxes are withheld on salaries. Distributions and dividends are not subject to employment taxes.
Forms
When you own a business, you must report your business’s gains and losses. The form you file depends on your business’s legal structure.
C Corp owners must file Form 1120, U.S. Corporation Income Tax Return. S Corp owners must file Form 1120S, U.S. Income Tax Return for an S Corporation. Shareholders of an S Corp must also use Schedule K-1 to report profits and losses on their personal tax returns.
On both forms, you must include information about your business, your Employer Identification Number (EIN), the date you incorporated, and information about your income, deductions, and taxes. Typically, both forms are due March 15.
Ownership
C corporations can have an unlimited amount of shareholders. However, S corporations cannot have more than 100 shareholders. There are other restrictions on who the shareholders can be, which are addressed later on.
Establishment
The process of forming a C Corp and S Corp is different. To form a C Corp, you must follow your state’s laws for incorporation. Consult your state to find out how to register your corporation. Register your business’s name with the state. You cannot choose a name that is already used.
Create a board of directors and issue stock certificates to shareholders. And, you need to file articles of incorporation and pay a fee to legally incorporate your business.
You can form a C Corp when you are choosing a business structure. However, you can only form an S Corp once you are structured as a C Corp.
| C Corp | S Corp | |
|---|---|---|
| Taxes | Double taxation | Pass-through tax |
| Formation | Can form by registering with the state | Can only form if already C Corp |
| Shareholders | Unlimited number of shareholders | No more than 100 shareholders allowed |
| Reporting Gains and Losses | Form 1120 | Form 1120S |
| How to Pay Yourself as a Business Owner | Salary | Salary and/or distributions |
| Fees | Fee to form | Ongoing fees (generally) |
How to convert C Corp to S Corp
Businesses that are domestic corporations (C Corps) can elect to become S corporations. But, there are other rules you must follow to convert C Corp to S Corp.
To become an S Corporation, you must change your tax year so that it meets one of the following requirements:
- Ends December 31
- Is a natural business year
- Is an ownership tax year
- Is a tax year elected under section 444
- Is a 52-53 week tax year that ends and references one of the other eligible years
- Is any other tax year the corporation establishes a business purpose for
If your business has 100 shareholders or fewer you are eligible to form an S Corp. A family of shareholders can count as one shareholder. Shareholders can’t be nonresident aliens, and they must be individuals, estates, exempt organizations, or certain trusts. Your shareholders must also consent to your business becoming an S Corp.
You cannot become an S Corp if you have more than one class of stock. Certain corporations are ineligible from becoming S corporations. Examples of ineligible corporations include banks that use the reserve method of accounting for bad debts and insurance companies taxed under subchapter L of the Code. For more information on ineligible corporations, consult the IRS.
Filing Form 2553
Converting from C Corp to S Corp doesn’t have to be difficult, but it does require additional action. To change from C Corp to S Corp, you must file Form 2553, Election by a Small Business Corporation.
There are four parts to Form 2553. To file, you need information like your corporation information, EIN, and shareholder’s consent statement.
Typically, you must file Form 2553 no later than two months and 15 days after the tax year begins. You can also file Form 2553 any time during the tax year before you want to become an S Corp. However, there is some relief for businesses that can prove they had a reasonable cause for filing late.
You can file Form 2553 by mailing or faxing it to the IRS. Make sure to also keep a copy for your records.
After you file to become an S corporation, the IRS will notify you (typically within 60 days) whether you successfully converted a C Corp to an S Corp. If your election is accepted, the IRS will tell you when you will become an S Corp.
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This article has been updated from its original publication date of December 19, 2017.
This is not intended as legal advice; for more information, please click here.
