What Are the Differences Between an S Corp and a C Corp?

S corp and C corp types of corporations will provide you with liability protection and some tax benefits; however, there are significant differences you need to be aware of when choosing one corporate structure over the other.

An S corporation (corp) and a C corporation (corp) are two different types of corporate designations that are used when filing taxes with the federal government.  Here are some of the most basic differences between an S corp and a C corp:

• A C corp is the standard corporation designation, and a C corp will only become an S corp if the proper measures are taken to file a Form 2553 with the IRS.
• An S corp, unlike a C corp, allows for “pass through taxation” to take place in order for the corporation to become an S-designated corporation.   

Special Tax Rules

• The fact that an S corp allows for "pass through" taxation is one of its most interesting features. Essentially, this means money made by the S corp is given to its shareholders (owners) and the money is then taxed at the regular income rate for each owner. There is no tax paid by the S corp when the money is distributed.
• A c corp is taxed on its corporate profits. In other words, if the business makes money, the business pays taxes on that money. Interestingly enough, if there are investors who receive a dividend, those investors have to pay tax on that dividend. This is true whether the corporation paying the dividend is a publicly-held company with thousands of investors or a closely held corporation with just a few. Because the company pays tax and the owners pay tax, a C corp essentially creates a "double taxation" system. Of course, there are other deductions and things allowed for C corps that make it worthwhile for people to form them anyway despite the double taxation rules.

Laws on S Corps and C Corps

There are also some differences in the legal rules and the legal treatment of S corps and C corps:

• Some states do not recognize S corps, while others do.
• Officers and owners of an S corp are required to be paid a salary by the company that is in keeping with the amount of work that they do, and that is considered to be reasonably fair for what they do.  This means that it is harder or impossible for S corp owners to avoid paying income taxes by not officially paying themselves a salary. 
• Employee benefits that are normally tax free for C corp employees may become taxable for S corp employees who own more than 2% stake in the company through the holding of shares of the corporation.
• The S corp set up allows a company to pass its profits on to shareholders, and as a result, all of the shareholders of an S corp must be legal United States citizens, according to the current federal laws on S corps. 
• In addition, there is only one allowed class of stock available to shareholders in an S corp, while C corps can have multiple classes of stock available to them.

So, now that you know the basic differences between an S corp and a C corp, you can make an informed choice on which business model is the right one for you to use.