Starting your business in the US – S-Corp or C- Corp?

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If you are starting or planning to start your business in the US, you might have a tough time selecting the type of entity you wish to form. In this article, we will talk about the two of the most common choices – an S-Corp and a C- Corp. Deciding between a C-Corp and an S-Corp is one of the most common questions business owners ask. To find an answer to that, one has to know the differences between the S corp and the C corp, as well as the pros and cons of an S corp and the pros and cons of a C corp. 

 

C Corporation vs. S Corporation: The Basics

Both C-Corp and S-Corp get their nomenclature from the Internal Revenue Code/Chapters that they are grouped under for tax purposes by the IRS. C corporations are taxed under Sub-chapter C while S corporations are taxed under Sub-chapter S.

The S corporation is a corporation that has elected a special tax status with the IRS and therefore has some tax advantages. The C corporation, on the other hand, is the standard (or default) corporation under IRS rules.  

To elect S corporation status when forming a corporation, Form 2553 must be filed with the IRS and all S corporation guidelines met.

C Corporation vs. S Corporation: The Similarities


Structure:
Both C Corps and S Corps have a corporate structure. That is to say that the shareholders are the owners of the corporation, but it is the corporation that owns the business. There is a Board of Directors that is elected by the shareholders. Corporation affairs and decision-making is their responsibility. Just like the Indian private limited companies. However, a major difference is that the Board does not take care of the day to day affairs of the corporation business. Instead, it elects the officers to manage daily business affairs.

Separate legal entities: Both C corps and S corps are separate legal entities created by a state filing. 

Limited liability protection: Both C corps and S corps offer limited liability protection, so shareholders (owners) are typically not personally responsible for business debts and liabilities. Hence, there is a corporate veil that exists.

Corporate formalities: The state corporation laws make no distinction between C corporations and S corporations when it comes to compliance responsibilities. All corporations are required to follow the internal and external corporate formalities and obligations, such as adopting bylaws, issuing stock, holding shareholder and director meetings, maintaining a registered agent and registered office, filing annual reports, and paying annual fees.

Filing documents: Formation documents must be filed with the state. These documents, typically called the Articles of Incorporation or Certificate of Incorporation, are the same regardless of whether you choose to be taxed as an S corporation or C corporation. 

 

We help businesses in registering their S-Corps/C-Corps – You might want to check this out for more details.

 

C Corporation vs. S Corporation: The Differences

 

Corporate ownership

While doing business is the US, one has to take care of the state laws as well as the IRS codes. While State corporation laws make no distinction between S corporations and C corporations, the Internal Revenue Code does place several restrictions on who can be shareholders in order for the corporation to qualify to be an S corp.

  • Shareholder restrictions: S corps are restricted to no more than 100 shareholders, and shareholders must be US citizens/residents. C corporations have no restrictions on ownership.

  • Ownership:  S corporations cannot be owned by C corporations, other S corporations (with some exceptions), LLCs, partnerships or many trusts.

  • Stock: S corporations can have only one class of stock (disregarding voting rights), while C corporations can have multiple classes.

Taxation

For small business owners evaluating S corporations vs. C corporations, the decision usually comes down to how they want the corporation to be treated for federal income tax purposes.

  • C corporations: C corps are separately taxable entities. They file a corporate tax return (Form 1120) and pay taxes at the corporate level. They also face the possibility of double taxation if corporate income is distributed to business owners as dividends, which are considered personal taxable income. Corporate income tax is paid first at the corporate level and again at the individual level on dividends.

  • S corporations: S corps are pass-through taxation entities. They file an informational federal return (Form 1120S), but no income tax is paid at the corporate level. The profits/losses of the business are instead “passed-through” to the business and reported on the owners’ personal tax returns. Any tax due is paid at the individual level by the owners.

C Corporation : The Advantages and Disadvantages

 

ADVANTAGES:
1. Unlimited number of shareholders
2. No restrictions on ownership – hence business entities and non-U.S. citizens can own its shares
 3. No restrictions on classes of shares – A C corp can issue more than one class of stock, including stock with preferences to dividends and distributions
4. Lower maximum tax rate
5. More options for raising capital
DISADVANTAGES
Double Taxation – The main disadvantage of the C corporation is that it pays tax on its earnings and the shareholders pay tax on dividends, meaning the corporation’s earnings are taxed twice. Hence, there is a concept of double taxation.

 

S Corporation : The Advantages and Disadvantages

ADVANTAGES
1.  No double taxation –The main advantage of the S corp over the C corp is that an S corp does not pay a corporate-level income tax. So any distribution of income to the shareholders is only taxed at the individual level
2. Pass-through of losses –The losses of an S corp pass-through to its shareholders, who can use the losses to offset income (subject to restrictions of the tax law)
3. Business Standard Deductions

 

DISADVANTAGES
1. Restriction on number of shareholders –An S corp cannot have more than 100 shareholders, meaning it can’t go public and limiting its ability to raise capital from new investors.
2. Restriction on class of shares – Preferred stock is not allowed in an S-Corp. Some investors want preferences to distributions or other privileges. An S corp cannot provide that.
3. Restriction on transfer of shares –Most S corps will restrict their shareholders’ ability to sell or transfer their shares. That’s to make sure they don’t end up with an ineligible shareholder which will cause the IRS to terminate its S corp status. This makes it harder for the shareholders of an S corp to exit the corporation.

 

When to choose an S Corp vs  C Corp?

When to choose S Corp When to choose C Corp
1. You do not plan an IPO  1. You plan on an IPO or seeking investors
2. The corporation will be making distributions of income to shareholders 2. Distributions will not be made to shareholders.
3. You don’t plan on issuing preferred stock. 3. Taxation under Sub-chapter C will result in lower taxes than taxation under Sub chapter S.
4. The shareholders’ tax liability—taking into account their personal income tax rate, deductions, and exemptions—will be lower using a pass-through entity than a separately taxed entity. 4. You want shares to be freely transferable.
5. You will have losses that you will be able to deduct from your personal income taxes to offset income, resulting in a tax saving 5. want to issue preferred stock.

 

There is no one size fits answer for this. The choice of an entity will depend upon your business goals/objectives.

To help you decide, you can talk to our global expansion experts – book your slots here – US Setting up and Compliance.

 

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For any query, support or feedback, reach us at US Setting up and Compliance or WA us at +91-9230033070 or Call us at 1800-102-7550

In these troubled times -COVID-19, we, at Taxmantra Global urge you to stay safe – social distancing, personal hygiene and health care are of utmost importance! Stay safe!

 

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