For entrepreneurs just getting started in legitimizing their small businesses, it’s easy to be confused by what it means to file an S Corp or C corp election. They’re both corporations, right? Are there any differences between the two or are they pretty much the same thing? And how does a business qualify to become one anyway? It’s time to set the record straight on what S corp and C corp elections are and why they matter so much for small business owners in our handy primer to these structures.
Defining S Corp and C Corp
First and foremost, it’s important to quickly clarify what S corp and C corp elections are and what they do for small businesses.
S corporations begin as C corporations or LLCs, making them a C corporation with an S corp tax election. S corps tend to operate in a similar style to corporations, but because of the S corp election, they are taxed as a partnership rather than as a corporation to avoid double taxation at the corporate level. Entities taxed as a partnership allow the corporation’s profits to pass through the entity level and are only taxed at the shareholder level. (More on that in a bit!)
C corporations, on the other hand, are a more traditional structure in which profits are taxed separately from the owners of the business. This entity may also be separate from its owners and may also go public, raise investment capital, initiate lawsuits and engage in business.
The Major Difference between an S Corp and C Corp
There’s one major difference between an S corp and C corp to keep in mind. As I mentioned earlier, S corps do not pay taxes at a corporate level because they are taxed as a partnership, which allows profits and losses to “pass through” and be reported on the shareholder’s individual tax returns. (C Corps are affected by double taxation, which has both benefits and downfalls.) Due to both profits and losses being passed through on the shareholder’s individual tax returns, they must be paid reasonable compensation or else the IRS may reclassify their corporate earnings as wages.
S Corp and C Corp Advantages
Curious about the benefits of electing either an S Corp or C corp? Here’s a look at what both have to offer businesses:
For an S corp, one of the biggest benefits comes for anyone with an LLC that elects for an S corp. If an LLC is taxed as an S corp, it may reduce self-employment taxes on salaries paid to the owner of the company. For C corps, they can claim more tax deductions than a partnership may be able to, write off benefits for employees (like health insurance) as business expenses, and are at much less risk of being audited as opposed to an LLC or sole proprietorship structure.
How do I qualify to be taxed as either an S corp or C corp?
For C corporations, make sure you file Form 1120 with the IRS. S corporations will need to make sure they meet specific requirements to qualify, including maintaining one class of stock, being filed as a U.S. corporation and having less than 100 shareholders, all of which must have a U.S. Social Security number and must be individuals, estates or certain qualified trusts. Once those requirements have been met, the shareholder may file Form 2553 to become a S Corp.