If your business has outgrown being a sole proprietor or single-member LLC, it may be time to consider a corporate structure. When choosing between corporations, consider not only your current needs but future ones. There are two major organizational structures that have some similarities but create different opportunities to protect your business and potentially save on taxes. Learn all about an S Corp vs a C Corp and choose for yourself!
What is the difference between S Corp and C Corp?
The main difference between S Corp and C Corp status is how you pay federal taxes.
In short, S Corps are common for a business-of-one, as a way to reduce the self-employment tax you pay on your individual income. C Corps pay corporate taxes and are more common for larger or more complex corporations with more than 100 shareholders or international business owners.
You’ll also face limitations on what types of businesses can be classified as S Corp or C Corp.
What is an S corporation?
An S Corp is a tax classification for what’s known as a “pass-through entity.” The IRS recognizes the classification and allows the company to pass its income and losses onto shareholders (which are the owners) for tax purposes.
That means the company doesn’t pay corporate taxes on income. Instead, it pays a salary to employees (if you’re a business-of-one, you as the sole employee-owner), and you pay individual income tax on the salary.
All S Corp shareholders must be U.S. residents, and the business must have no more than 100 shareholders.
S Corp vs. LLC
An S Corp and LLC aren’t competing options. They serve different purposes, but might work in tandem for your business.
An S Corp is a tax election, a classification the business owner chooses that determines how the business is taxed by the IRS. An LLC (limited liability company) is a legal entity, a way of organizing a business that keeps an individual’s personal assets separate from business assets.
As a business-of-one, you might organize as a single-member LLC. That would keep your personal assets — like your home, car and investments — separate from your business assets — like savings accounts and real estate. That saves you from forfeiting everything you own personally to pay off debts or lawsuits for the business.
Once you’ve formed a separate legal entity for the business, such as an LLC, you could elect to file taxes as an S Corp to treat the LLC as a pass-through entity. If you don’t elect to file as an S Corp, you’ll automatically pay taxes as a sole proprietor (or partnership, if there are multiple owners).
For a business-of-one, a common set up is to form a single-member LLC taxed as an S Corp.
S Corp taxation
Business income for an S Corp is taxed just once at the individual owner’s level.
You pay yourself a salary, which must be “reasonable compensation,” and it’s taxed as employee earnings (like a typical paycheck). You don’t pay the self-employment tax on that salary, the way you do if you’re a sole proprietor. If your business has multiple owners (shareholders), each owner reports their salary the same way, as individual income.
Like any other employee, an S Corp’s owner-employees’ wages are subject to FICA payroll taxes, which cover Social Security and Medicare. FICA taxes are split like this:
- The company (your business) pays tax of 7.65% of the salary.
- The employee pays tax of 7.65% of the salary.
- The employee pays personal income tax based on their tax bracket.
You don’t pay the employment tax on the business’s profits, so this could save you some serious money compared with filing as a sole proprietor, where you pay employment tax on everything the business earns.
What is a C Corporation?
A C Corp is a tax classification for companies with an unlimited number of owners and potentially international shareholders. For tax purposes, a C Corp pays corporate taxes, and shareholders pay income taxes on dividends they receive.
Because owners don’t have to be U.S. residents, a C Corp is the best option for international investors and entrepreneurs who want to build a new business in the U.S.
C Corp vs. LLC
Like an S Corp, a C Corp is a tax election that determines how a business pays taxes to the IRS. LLC is a legal entity that determines how assets are owned between individual owners and the business.
You could elect to have your LLC taxed as an C Corp, but it’s complicated and not a common route. Instead, to be taxed as a C Corp, you’d need to form a corporation, a more complex legal entity than an LLC.
C Corp taxation
A C Corp pays taxes twice on income: The business pays corporate taxes, then individual shareholders pay income taxes on any salary they receive, plus dividends they receive from business profits.
This sounds hefty. But the classification may be beneficial for large companies, which can cut their tax bill through a lower corporate tax rate, corporate tax breaks that don’t apply to individual income taxes and splitting profits among several shareholders.
S Corp vs. C corp vs. LLC vs. LLP: At a glance
S Corp vs. C Corp: pros & cons
Both S Corps and C Corps come with benefits and disadvantages, depending on what type of company you run.
Benefits of an S Corp
- Easy and affordable to form.
- No corporate taxes on business income.
- Potential savings on self-employment tax compared with sole proprietorship.
- 20% pass-through deduction on qualified business income (QBI) under the Tax Cuts and Jobs Act of 2017.
- Loss balancing — ability to claim business losses on your personal return to reduce taxable income.
Disadvantages of an S Corp
- File a business tax return and a personal tax return (unlike sole proprietorship, where you only file a personal return).
- Limited to 100 shareholders.
- S election is only guaranteed at the federal level; you may be taxed differently in your state.
- Audits are common because of initiatives by the IRS to curb abuse of the taxation structure. If you form an S Corp we recommend you work with a tax professional to ensure you’re staying compliant.
Benefits of a C Corp
- Unlimited shareholders.
- Shareholders don’t have to be U.S. residents.
- Best tax structure to attract investors or sale.
- Access to corporate tax advantages.
Disadvantages of a C Corp
- Double taxation on business income.
- Generally requires forming a corporation, a complex and costly legal entity.
Is it better to be an S Corp or C Corp?
If you’re self-employed and running a business-of-one or small business, forming an LLC taxed as an S Corp is likely your best route. Freelancers and independent contractors often shift from a sole proprietorship to an LLC with S Corp status for liability protections and tax advantages.
However, it could come down to location. For those with global interests, C Corp may be your only option.
Consult with a lawyer and an accountant to determine what makes the most sense for your situation.
You may be a fit for an S Corp if you answer “yes” to these questions:
- Am I a U.S. resident with 100 or fewer shareholders in the business?
- Do I prefer the perks of being taxed once, enjoying 20% QBI deductions and loss balancing against other forms of income?
- Am I looking at possible asset liquidation or a complete selling off of my business in the next 10 years?
You may be a fit for a C Corp if you answer “yes” to these questions:
- Would I like to sell shares of my business now or in the future?
- Am I looking to grow my business to include more than 100 shareholders?
- Am I a U.S. non-resident?
- Am I interested in investments from angel investors?
- Am I a high rate taxpayer who may benefit from lower corporate income tax rates?
How to become an S Corp or a C Corp
Your tax status starts with the legal structure of your business.
If you don’t form a legal entity and simply run your business as an individual, you’re taxed as a sole proprietorship. If you form an LLC or corporation, you have options for taxation.
Forming an S Corp
By default, a single-member LLC is taxed as a sole proprietorship, and a multi-member LLC as a partnership. You can elect, instead, to have your LLC taxed as an S Corp if you prefer.
Creating an S Corp is relatively painless:
Once formed, maintaining your S Corp status is as simple as filing a form with your state office each year to keep your LLC information up to date.
Forming a C Corp
If you form a corporation, it’s automatically taxed as a C Corp. To do that, you have to file articles of incorporation with your state to set up the legal entity.
If you’re running an LLC, you could elect to switch from an S Corp to a C Corp for some tax advantages the IRS points out, including a 21% flat corporate tax rate that might be lower than your individual rate, depending on your tax bracket.
There’s no form to switch from S Corp to C Corp status. Instead, you have to file a written statement with the IRS, signed by at least 51% of the company’s shareholders.
FAQs about S Corp vs. C Corp
Business and tax structures are confusing when you’re just getting started, and it’s easy to conflate or misunderstand your options. Here are some common questions that come up around how to structure your business — and our answers to help you sort it all out.
Why would you choose an S Corporation?
A business-of-one taxed as a sole proprietorship may be aching from self-employment taxes. Forming an LLC taxed as an S Corp is a way to reduce that tax burden.
Is my LLC an S or C Corp?
You can elect for an LLC to be taxed as an S Corp or a C Corp by filing the proper paperwork with the IRS. If you run an LLC, it’s automatically taxed as a sole proprietorship or partnership, but you can elect to be taxed as a corporation instead. S Corp is the more likely choice for an LLC, while C Corps are usually corporations.
Which is better for taxes, LLC or S Corp?
LLC isn’t a tax election but rather a legal structure for your business that protects your personal assets from business liabilities. S Corp is a tax status that determines how you pay taxes as a business owner. As a business-of-one, you could form an LLC (for legal purposes) and elect to be treated as an S Corp (for tax purposes) — so you’d be both an LLC and an S Corp.
What is a reasonable S Corp salary?
As a general guideline, reasonable pay should be an amount similar companies would pay for the same or similar services. The IRS doesn’t offer a clear formula but does provide some guidance on “reasonable compensation.” The point is that you can’t lowball your salary just to save on taxes.
Do S Corp owners have to take a salary?
Generally, yes, you must take a salary as a shareholder in an entity taxed as an S Corp. That falls under the same rules requiring the amount be “reasonable compensation” — if you’re performing work for the company, your salary has to be in line with what a similar business would pay for your services. If you wouldn’t do the work for free for any other company, you can’t do it salary-free for your own company.
TL;DR: Key S Corp vs. C Corp differences
The big takeaway here: The main difference between an S Corp and a C Corp is how they’re taxed.
C Corp status business owners pay taxes twice — at the corporate and individual level — while S Corp status owners only pay income taxes on the combined earnings of the owner-employee’s wages and pass-through profits.
In most cases, you probably won’t need to choose between S Corp or C Corp status for your taxes. The decision is driven by your legal business entity.
As an LLC, you can elect S Corp status instead of the default sole proprietorship or partnership. As a corporation, you’ll automatically be taxed as a C Corp. A larger LLC might want to elect C Corp status for a lower tax rate or to appeal to future investors or buyers.
In the end, your choice may be as simple as “Do I want to be double-taxed?” That’s the criteria many S Corp status owners have used to support their decision, and it’s worked out well for them.
Form your S Corp with Collective
Collective makes setting up and running your business-of-one simple and affordable. Our members save an average of $16,845* in taxes. See how much you could save with Collective.Estimate your tax savings