The difference between a C-Corporation and an S-Corporation is in the way each is taxed. Under the law, a corporation is considered to be an artificial person. Shareholders who work for the corporation are employees; they are not “self-employed” as far as the tax authorities are concerned.
In theory, before a C-corporation distributes profits to shareholders, it must pay tax on the income at the corporate rate. Then, leftover profits are distributed to the shareholders as dividends, which are then treated as investment income and taxed to the shareholder. This is the “double taxation” you may have heard about.
C-Corporations enjoy many tax-related advantages :
- Income splitting is the division of income between the corporation and its shareholders in a way that lowers overall taxes, and can avoid or significantly reduce the potential impact of “double taxation.” By working with a knowledgeable tax advisor, you can determine exactly how much money the corporation should pay you as an employee to ensure the lowest tax bill at the end of the year.
- C-Corporations enjoy a wider range of deductible expenses such as those for healthcare and education.
- A shareholder can borrow up to $10,000 from a C-Corporation, interest-free. Tax-free loans are not available to sole proprietors, partners, LLC members or S-Corporation shareholders.
S-Corporations pass income through to their shareholders who pay tax on it according to their individual income tax rates. To qualify for S-Corporation status, the corporation must have less than 100 shareholders; all shareholders must be individual U.S. citizens, resident aliens, other S-Corporations, or an electing small business trust; the corporation may have only one class of stock; and all shareholders must consent in writing to the S-Corporation status.
Depending on your situation, an S-Corporation may be more advantageous:
- Electing S-Corporation tax treatment eliminates any possibility of the “double taxation” referenced above. S-Corporations pay no federal corporate income tax, but must file annual tax returns. Because losses also flow through, shareholders who are active in the business can take most business operating losses on their individual tax returns.
- S-Corporations must still file and pay employment taxes on employees, as with a C-Corporation. An S-Corporation may not retain earnings for future growth without the shareholders paying tax on them. The taxable profits of an S-Corporation pass through to the shareholders in the year they are earned.
- S-Corporations cannot provide the full range of fringe benefits that a C-Corporation can.