Taxation
Topic
Understanding the basic differences between an S Corp and a C Corp can help save time, money and effort. Both S corporation and C Corporation designations are valid choices. Although both have similarities, they also have quite a few important differences. Before taking the final call, it is better to understand the differences between the two.
There are a lot of things common between S corporations and C corporations.
Whenever a corporation is formed, initially, it is a C corporation. There after a C corporation can be converted to an S corporation by filling out a form and a small business corporation election with the IRS (internal revenue service). There could also be state forms to file an S corp status for state tax purposes.
To obtain an S Corp status for a certain year, a specific form has to be submitted no later than the financial closing for that year in case the business is following the calendar year basis.
For corporations operating in an alternative fiscal year, the form must be submitted no later than the 15th day of the third month of that fiscal year. But, of course, it can also be submitted at any time during the previous tax year.
The main reason why people go for an S Corp is tax saving. However, there is a big difference between the taxation of an S Corp and a C corp. For federal taxes, the profits of C Corp are taken into account and reported through the corporation tax return.
After tax profits, if any, the profits are distributed to shareholders in the form of dividends and are taxed again. Shareholders then report the same through personal tax returns. Such double taxation can be avoided by opting for an S Corp status for the business.
An S Corp business is treated the same as a partnership or sole proprietorship. The profits, or the losses, are passed through the S Corp to the shareholders, taxed, and reported through personal tax returns. Many states pass the profit and loss to the proprietors of S Corp. However, a few states engage in double taxation of S Corps too.
C Corp can extend more flexibility when selling stock shares. As per the IRS, an S Corp business:
● Cannot exceed 100 shareholders.
● Must be a domestic corporation.
● Issue more than a single class of stock.
● Be owned by C Corp, other S Corps, LLCs, partnerships, or trusts.
For C Corps, none of the above restrictions applies, which can help the company to expand. For instance, having more than a single class of stock can help a business raise investments from investors without allowing them any voting rights.
A business may look to extend certain benefits to its employee shareholders, like life, health, disability, etc. If the business is a C Corp, the cost of such benefits can be reduced and are not taxable to shareholders, provided the benefit is extended to a minimum of 70% of the employees.
On the other hand, an S Corp can't deduct the cost of the benefits and is taxable to the shareholder holding more than 2% of the stock.
Usually, small businesses prefer the S Corp status since it fits within the legal limitations. However, certain categories of corporations get more advantages with a C Corp status.
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