In today's world, choosing the type of business structure that you want for your company is an extremely important decision. There are many different components to consider by examining the advantages and disadvantages. If you have chosen the corporation business structure, your decisions are not yet complete. You must now decide whether to go with an S corp or a C corp.
In the articles of incorporation that you file with the Secretary of State, it does not distinguish between the two types of corporations. If you do not take action during the business formation process and choose between the two, it will automatically be a C corp. That is because all corporations that are filed under the subchapter "C" of the tax code are C corporations. The only way to change this, if you do prefer an S corp, is by filing for S status. The differences between the two are focused completely on taxes, so it is something to consider before you automatically convert to a C corp. When the one-page "S election" is filed with the IRS, the corporation is taxed like an LLC or a partnership. Below, we take a deeper look at the taxation differences.
Although taxes are the biggest difference that separate the two business entities, there are many similarities between the two. No matter which one you choose, there are some benefits you can enjoy. These are some of the main similarities and benefits of each:
For a corporation to be eligible for S corp status, the corporation must have a maximum of 100 shareholders. In addition to that requirement, the shareholders must all be U.S. citizens or resident aliens. The shareholders are generally individual shareholders as S corps are not eligible to be owned by a C corp, another S corp, an LLC, a partnership, or a trust. The corporation must also have a calendar fiscal year and multiple classes of stock. If these exist, then only differences in voting rights are allowed. Something to keep in mind is that C corps do not have any restrictions on ownership like an S corp does. C corps can have multiple classes of stocks regardless of voting rights, and because of this, C corps do offer a bit more flexibility for a growing business with plans to expand ownership or even sell the corporation at a later date.
If you are not sure what your long-term goals are for the corporation, choosing between an S corp and a C corp can be a daunting task. You may be wondering if you can change the filing at a later date. The answer to that question is both yes and no depending on if you are willing to pay the corporate taxes on conversion from an S corp to a C corp. One thing to keep in mind is that if you choose to file your corporation as an S corp at your initial filing, then you never have to worry about the built-in gain tax on conversion. If you have chosen to file your corporation as a C corp, you can change it to an S corp at any time without paying this tax conversion.
You can also convert from an S corp to a C corp, but you will face a corporate tax if it was previously a C corp that elected S status within the past 10 years. If it has been at an S status for more than 10 years, you will not have to pay this additional tax upon conversion. If you want an S corp, it is always best to choose this when starting out so you can save yourself from paying the extra taxes at a later date when you convert.
As mentioned, there is an extra step you must take if you want to elect the S classification for your corporation. You have 75 days from forming your corporation to file the S election if you want to avoid the additional corporate tax mentioned previously. The form you will want to file with the IRS is the Form 2553. The form can be complicated to understand because there is a time frame for you to submit it based on your tax year. If you want your election to be effective in the current tax year, then you must meet one of the following requirements:
One thing to keep in mind is that your state may require you to also file a state S corp election form after you have incorporated your business. You should check your local laws to ensure that you have filed all of the necessary documentation for both the IRS and your state and local governments.
Taxes are a huge factor when choosing between these two types of corporations, but it is not the only thing you should consider. These are some of the reasons you may want to choose an S corp over a C corp. The first two are also benefits for choosing an S corp over an LLC.
Just like there are specific reasons why you may want to choose an S corp over a C corp, there are some other advantages for choosing a C corp. These are just some of the reasons why you may consider it for your business structure:
There is no right or wrong answer when you are choosing between an S corp and a C corp. Both of these types of business formations have similarities that you can benefit from. Knowing the major differences can help you decide which one is best for you. For most small businesses, the double taxation for a C corp may not be a smart move, but there may be other components of a C corp that you require for your business. Since the main differences are the taxes of both, this is one of the main components you will want to pay attention to because it can make a big difference for the future of your business. If you are still unsure of which is the better option for your business, you should consult with a professional for advice.
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