When starting a business, one of the most important decisions to make is choosing the right legal structure. Two common options for small businesses in the United States are C Corporations (C Corps) and S Corporations (S Corps). While both are types of corporations, they differ in several key aspects.

C Corporation (C Corp)

A C Corporation is a separate legal entity from its owners, known as shareholders. It offers limited liability protection, meaning the shareholders are generally not personally liable for the corporation's debts or legal liabilities. C Corps have the advantage of being able to issue multiple classes of stock, allowing for flexibility in ownership structure and attracting potential investors.

One significant advantage of a C Corp is the ability to have unlimited shareholders, which can be ideal for businesses planning to go public or seeking substantial growth. Additionally, C Corps provide the opportunity for tax planning and deductible expenses, such as employee benefits and business travel.

However, C Corps do have some disadvantages. They are subject to double taxation, where the corporation is taxed on its profits, and the shareholders are taxed on any dividends received. This can result in a higher overall tax burden. C Corps also require more formalities, such as holding regular board meetings and keeping detailed corporate records.

S Corporation (S Corp)

An S Corporation is also a separate legal entity that offers limited liability protection to its shareholders. However, it differs from a C Corp in terms of taxation. S Corps are pass-through entities, meaning the profits and losses are passed through to the shareholders' personal income tax returns. This avoids the issue of double taxation.

One significant advantage of an S Corp is the ability to avoid self-employment taxes on profits. Unlike C Corps, where all profits are subject to self-employment taxes, S Corps allow business owners to pay themselves a reasonable salary and receive additional profits as dividends, which are not subject to self-employment taxes.

However, there are limitations to forming an S Corp. S Corps are limited to a maximum of 100 shareholders, and only individuals, certain trusts, and estates can be shareholders. Non-resident aliens and most corporations cannot be shareholders. Additionally, S Corps are subject to strict eligibility requirements, such as having only one class of stock and being a domestic corporation.

Choosing the Right Option

Determining whether to form a C Corp or S Corp depends on various factors, including the business's goals, ownership structure, and tax considerations.

If a business is planning for substantial growth, attracting investors, or going public, a C Corp may be the preferred choice. C Corps offer flexibility in ownership structure and have no limitations on the number of shareholders.

On the other hand, if a business has a smaller ownership structure, wants to avoid double taxation, and meet eligibility requirements, an S Corp may be a better fit. S Corps allow for pass-through taxation and can provide potential tax savings.

Consulting with an attorney or a tax advisor can help business owners make an informed decision based on their specific circumstances.

Conclusion

C Corps and S Corps differ in terms of taxation, ownership structure, and eligibility requirements. C Corps offer flexibility and the potential for growth, but are subject to double taxation. S Corps, on the other hand, have pass-through taxation and limitations on ownership and eligibility. Choosing the right legal structure depends on the business's goals and circumstances. Seeking professional advice is crucial to make an informed decision.