What’s the Difference Between an S Corporation and a C Corporation?

I had one of my non-U.S. clients ask me this question last week. Legally, there are only a few differences, but they are pretty significant. And from a tax perspective, the two are worlds apart.

First, the legal similarities. Both entities are corporations. They both file Articles of Incorporation with the appropriate Secretary of State’s office. They both have Officers and Directors, and they both have Shareholders. The type of paper work you file each year with the Secretary of State is the same. There is no separate Annual Report or Articles for a C Corporation or an S Corporation.

Now for the legal differences: An S Corporation is limited in the number of shareholder it may have. You can have no more than 100 shareholders, although you can count related family members as a single shareholder.

All S Corporation shareholders must be US residents. They should also be real people, although there are a couple of exceptions to that rule (some trusts and a single member LLC that elects disregarded taxation).

Legally, the asset protection extended to S Corporations and C Corporations is the same (except in Nevada, which gives extra protection to S Corporation owners). If you are an officer, director or shareholder in the Corporation you generally won’t be found liable for the acts, deeds and debts of the company, unless you did something illegal.

Now for the tax side. From this perspective, the two are very different.

  1. A C Corporation can have shareholders anywhere in the world. An S Corporation must have shareholders located in the United States.
  2. A C Corporation can have shareholders who are individuals or other companies. An S Corporation can only have shareholders who are real people, some trusts, or single member disregarded LLCs.
  3. A C Corporation can go public and sell its shares on the open market, without restriction. An S Corporation cannot, because of the number of shareholders (100) and the US resident restriction.
  4. A C Corporation files a tax return and pays taxes at its own special corporate tax rate. An S Corporation files a tax return, but flows the net income or net loss through to its owners on a percentage basis, based on their ownership. Each owner then needs to declare the income or loss on their personal tax return and pay at their own rate. That’s why non-US shareholders aren’t allowed.
  5. An S Corporation can pass a net loss through to its owners, who can use that to offset their other income. A C Corporation cannot. It must hold the net loss internally and carry it forward until it has income to offset the loss.
  6. A C Corporation can provide medical benefits to its owners and employees, and have the benefits be considered an expense to the company and a non-taxable benefit to the employee-owners. An S Corporation can provide medical benefits to its owners and employees and expense the cost of both, but the owners must treat their benefit received as taxable.
  7. A C Corporation can be owned by an S Corporation. An S Corporation, though, cannot be owned by a C Corporation.
  8. A C Corporation can choose whether or not to distribute its net, after-tax profits out to the shareholders. Each shareholder must then declare the amount of those net profits (called a dividend) on his or her return and pay tax on it at the current capital gain rate. An S Corporation is always considered to pay out all of its net, before-tax profit to its shareholders.

There’s a place for each kind of Corporation. The one that will work best for you is something you probably want to determine with your tax and legal advisors. Neither angle has all the answers! You need to see which is best from both a legal AND a tax side before making your decision.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

Got questions? Contact us! We’re here for you.

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