If you are looking to incorporate your business, you’re probably wondering whether you should form an S corporation or C corporation. S-corps and C-corps have quite a bit in common with one another. However, there are some key differences that you should be aware of when choosing between the two.
S Corporation or C Corporation: Similarities
S-corps and C-corps are both a type of business entity that can protect your company and your assets. The owners are the shareholders, and elected shareholders serve as directors for the business. These directors are responsible for the general management of the company. Shareholders divide the profits among themselves, based on the percentage of the business (number of shares) each one owns.
Whether you form an S corporation or C corporation, you must draft a set of by-laws, file yearly reports with your state government, and pay annual fees. Shareholders must also attend annual meetings and keep minutes of these meetings. If you fail to meet any of these requirements, the state government may dissolve your corporation.
Both S-corps and C-corps provide personal liability protection by defining your business as a separate entity with its own finances. This means that shareholders are not personally responsible for business debt. Creditors cannot come after the shareholders’ personal assets for repayment of corporate debt. Incorporating your business also protects the business name. No one else in the state you incorporate in can use that exact name.
S Corporation or C Corporation: Differences
Taxation method is the biggest difference between an S-corp and a C-corp. The IRS subjects C corporations to something known as “double taxation. ” Any profits that the corporation generates are reported on the business’s tax return and taxed accordingly. The net profit, after taxation, gets distributed to the shareholders and taxed again on their personal tax returns.
On the other hand, S-corps can opt for “pass-through” taxation. In this case, the company is not required to file a business tax return. Instead, all profits get distributed to the shareholders and reported on their personal returns only. When choosing whether to form an S corporation or C corporation, you should familiarize yourself with your state tax regulations. Some states allow pass-through taxation for S-corps, while others enforce double taxation for both types of corporations.
In addition, S-corps have some extra restrictions. S-corps cannot have more than 100 shareholders, and only U.S. citizens or residents cab be shareholders. Other companies cannot own the business, only individuals. Also, an S corporation can only issue one class of stock. Finally, employee benefits and insurance are not tax-deductible. Whereas, C-corps can deduct these expenses, as long at least 70% of employees participate.
How to form a C-corp
You will need to register your C-corp with the state government office responsible for business incorporation. This is typically the Secretary of State. First, you will need to decide which state you will incorporate in. You can incorporate in the state where you live or operate your business. However, you have the option to incorporate in any state you want. Some states offer unique advantages or tax benefits, so it’s worth looking into.
Next, you will need to choose a name for your corporation. On the Secretary of State’s website, you should be able to search the registered names and ensure that your name is not already taken. Then, the shareholders must elect directors to manage the business. When you have chosen the directors, you can file your articles of incorporation with the state and pay your filing fee.
The Secretary of State accepts your articles of incorporation, they will send you a certificate of incorporation. Once your incorporation is official, you can apply for an employer identification number (EIN), issue stock to your shareholders, and register for any required permits or licenses.
How to form an S-corp
All corporations start off as C corporations and must file for S corporation status. So, to form an S-corp, you will need to follow the steps listed above. When your corporation is officially formed, you can file IRS Form 2553 to register as an S corporation. Corporations can obtain S- corp status at any time, even years after formation. However, there is a limited window each year to apply.
Newly formed corporations must file Form 2553 within two months and 15 days of the start of their first tax year. Existing corporations must file Form 2553 within two months and 15 days of the start of their current fiscal year. If you are late filing, S-corp status will not apply until the next year.
Is an S corporation or C corporation better for small businesses?
In general, S-corps are better for small businesses looking for a tax break. While C-corps are more appropriate for large companies who need extra shareholder and stock options to raise more capital. Ultimately, it’s up to you to determine whether an S corporation or C corporation is the better option for your business. However, keep in mind that you can always elect S-corp status in the future. It’s not necessary to choose right away.
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