Businesses can be set up as either an S corp or a C corp. Understanding the difference can have a big impact on your business structure, so it's important to weigh the pros and cons of each option. Here are a few things to know:
Similarities Shared by S Corps and C Corps
The C corporation is the standard corporation under IRS rules. The S corporation, on the other hand, provides special tax status to a business and has certain tax advantages. Both structures get their name from the parts of the IRS code they are taxed under. Both versions offer limited liability protection and have shareholders, officers, and directors. State corporation laws make no distinction between S corps and C corps. That means your organization must adopt bylaws, issue stock, hold shareholder and director meetings regardless of whether it is classified as an S corp or C corp.
Differences Between S Corps and C Corps
When small business owners decide between S corps and C corps designation, the decision often comes down to how they want their taxes to be handled. C corps are separately taxable entities, meaning they file a corporate tax return each year. They face double taxation if corporate income is distributed as dividends to business owners. That's considered personal taxable income. Corporate income tax is paid at both the corporate income level and again when it is distributed as dividends to business owners.
S corps, on the other hand, are considered pass-through taxation entities. While they file an income tax return each year, no income tax is paid at the corporate level. Instead, the profits and losses are passed on to the business owners and reported on their personal tax returns. Any taxes due are paid by the business owners. With both S corps and C corps, personal income tax is due on salaries drawn from the business and on dividends received by the corporation.
S Corps Advantages
The single layer of taxation gives S corps an obvious advantage. By not paying any corporate-level income taxes, the organization distributes income to shareholders directly. Since losses are passed on to shareholders, they can use the losses to offset taxable income. The 2017 Tax Cuts and Jobs Act also gave eligible S corps shareholders a deduction of up to 20 percent of net qualified business income.
C Corps Advantages
The unlimited number of shareholders allowed for C corps is an obvious advantage. With no restrictions on ownership, anyone can own shares, including non-U.S. citizens and business entities. C corps can also issue more than one class of stock, including stocks with preferences to distributions and dividends. A lower maximum tax rate and more options for raising capital also give C corps the edge over S corps.
Your decision of entity type can have a serious impact on the fate of your business. A trusted tax lawyer can help you weigh the advantages and disadvantages to set you up for success.
Contact Gabaie & Associates, LLC for a free consultation about your federal or Maryland tax filings. We have convenient offices located throughout Maryland, in Annapolis, Baltimore, Columbia, Frederick and Rockville. Call us at (410) 358-1300 if you have questions about different entity classifications.