What Are the Tax Implications of a C-Corp vs. an S-Corp?

As you’ll probably already know, business are built on a host of decisions, big and small. One such decision is the type of entity you choose to register your business as and what implications this decision has for your business tax-wise. In this blog, we’ll go through the differences between an S-Corp and a C-Corp, the advantages and disadvantages of these corporation types, and how exactly they could impact your taxes.

What is a C-Corp and an S-Corp? The Differences

Registering to your incorporate your business is just the start, because you as a business also have to decide what type of corporation you will become. Your choices? A C-Corp or an S-Corp. Both of these corporation types get their names from the section of the Internal Revenue Code that governs how they are then taxed. But what’s the difference?

A C-Corp is the default type of corporation, so you don’t have to actually do anything more than register to incorporate your business. To form your company as an S-Corp, however, you would need to file a further a form – IRS Form 2553. After filing the Form 2553, your company will become an S-Corp for federal tax purposes, but you might have to file additional documents at the state level so you’re also treated as an S-Corp for tax purposes in your state.

Another difference between the two types of corporation is ownership. Registering as a C-Corp will mean your company has no restrictions on ownership. You can have as many as you like! However, if you choose to become an S-Corp, your company will be limited to 100 shareholders, and all will have to be U.S citizens.

C-Corps can also issue multiple classes of stock, such as common and preferred shares. Whereas S-Corps can only have one class, meaning there’s only one type of shareholder which could make fundraising more difficult.

Pros and Cons of a C-Corp

Like anything, both corporation types come with their advantages and disadvantages, and it’s up to you as a business to weigh up both sides to see which type works best for you.

Pros

• Easy formation – As mentioned above, C-Corps are much easier to form due to it being the default corporation type, so there will be less paperwork and admin to go through.
• Flexible ownership – Being a C-Corp also means you aren’t restricted in ownership, and so if you’re planning on potentially selling your company in the future, this one is for you.
• Raising capital – Due to the unlimited number of shareholders and the issuing of multiple classes of stock, it can make looking for funding through investors much easier too.
• Overseas business – C-Corps aren’t restricted to shareholders in the U.S, and so if you’re looking to develop your business overseas, then this corporation type may be the better fit.

Cons

• Double taxation – The main disadvantage to a C-Corp is that your business will face taxation at the corporate level and then again at the personal level if your company’s revenue is distributed as shareholder dividends. It means you could be losing money twice on your income, which could prove costly to many smaller businesses.
• No write offs – Being a C-Corp also doesn’t allow owners to write off tax on their personal income tax returns.

Pros and Cons of an S-Corp

Pros

• Pass-through taxation – For an S-Corp, its biggest advantage is its taxation structure. Businesses don’t have to pay twice on their income, they only need to report business income and loss on personal income tax returns.
• Income deduction – You can also deduct up to 20% of the income on your personal tax returns if you’re registered as an S-Corp.
• Tax write offs – You can write off your business’s losses on your personal tax returns. This is quite a significant advantage for newer businesses that are likely operating at a loss for the first few years.

Cons

• Harder to form – To register as an S-Corp, you have to go through additional paperwork both at the federal and state level, which could use up a lot of time, energy, and resource in your business.
• Limited ownership – As we’ve already mentioned, becoming an S-Corp will mean you will have to operate under restrictions when it comes to ownership. You will be limited to 100 shareholders and they all have to be U.S citizens.
• Harder to fundraise capital – And due to this limited ownership, it also means only one class of stock can be issued, so fundraising money from investors may prove to be more difficult because there’s no room to incentivize.

How Do These Corps Impact Your Company’s Taxes?

Knowing how your chosen corporation type will impact your business’ finances and tax obligations is vital.

For a C-Corp, you’ll be faced with a double taxation – the corporation will have to pay federal income tax on the net income, and the shareholders will have to pay federal income tax again on any dividends they receive. While C-Corp profits are indeed taxed twice, since the 2017 Tax Cuts and Jobs Act was brought in, the taxes C-Corps have to pay are a flat rate of 21%, regardless of income or company size.

For an S-Corp, you’re considered a pass-through entity for tax purposes, which means you’re your shareholders report their share of the business’ income and losses on their personal tax return. You will only have to pay taxes once at your personal income tax rate—you wouldn’t be subjected to any corporate tax. Additionally, S-Corps can deduct 20% of their income on their personal tax returns.

Undecided on Being an S-Corp or a C-Corp?

If you’re still undecided or need help in making your decision, then we’re here to help! Simple Startup can help you prep and file your business tax returns as well as provide ad-hoc and tax advisory services when you’re considering which entity is right for your business or preparing to change from one entity to another. So, reach out to us to see how we can help in shaping your business to be in the best possible financial position it can be.