When you're starting a small business, one of the first decisions you'll have to make is what kind of legal entity to set up. Two of the most common options are S corporations (S corps) and C corporations (C corps). Both have their pros and cons, so it's important to understand the differences before making a decision. Here's a quick overview of S corp vs C corp to help you decide which is right for your business.
Both S corps and C corps are types of business entities that offer limited liability protection to their owners. That means that if the business is sued or incurs debt, the owners' personal assets are shielded from seizure.
The main difference between S corps and C corps is how they're taxed. S corps are "pass-through" entities, which means that business profits are passed through to the owners and taxed at their individual income tax rates. C corps, on the other hand, are taxed as separate entities. That means that they pay corporate income tax on their profits at the federal, state, and local levels.
Another key difference between S corps and C corps is that S corporations have restrictions on ownership. In order to qualify as an S corp, a business must meet the following requirements:
Meanwhile, there are no ownership restrictions for C corporations. That means that they can be owned by other businesses or by foreign investors.
There are several advantages and disadvantages of both S corps and C corps that you should consider before making a decision about which type of entity is right for your business.
- Pass-through taxation can save you money on taxes because you only have to pay taxes once at the individual level
- No limit on the number of shareholders
- Easier to raise capital because there are no ownership restrictions
- Can deduct business expenses like salaries, rent, and depreciation from taxable income
- Owners have limited liability protection
- May be subject to "double taxation" if profits are distributed to shareholders in the form of dividends
- Shareholders must take reasonable salaries, which may reduce profits available for distribution
- May be difficult to sell because there can only be one class of stock
- Profits are subject to corporate income tax at the federal, state , and local levels
- More expensive to set up and maintain than an LLC or sole proprietorship
- Complexity may make it difficult to comply with all regulations
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