Corporations in general share some common characteristics. However, not all corporations are the same.

In the US, for instance, there are two different types of corporations i.e. C-Corp and S-Corp, and despite some commonality, there are more prominent, and distinct differences between the two different business structures.

From taxation, to the internal business structure, the differences between S and C corporations become clearer the further you look into them.

The S Corporation Defined

The “S” in “C corporation” comes from one of the subchapters of the U.S. Internal Revenue Code (Code 26), a document that states laws regarding taxation. An S corporation is called so because the company filed under Subchapter S.

What separates this from a C corporation, however, is the way in which it is taxed. Other characteristics of an S corporation include a limited number of shareholders and the classes of shares it can offer.

What’s in an S corporation?

An S corporation model is one that a small business may be better off with as it first enters the corporate world. While there exist limits to running such a business, such as tighter regulations than those of a C corporation, the benefits, such as lower overall taxes, are attractive enough for consideration.

An S corporation is established similarly to a C corporation. This includes having registered agents, as well as filing articles of incorporation and paying the fees associated with such a process. After all, an S corporation is still a corporation by definition, albeit a different kind.

One of the default characteristics of a corporation is limited liability. Similar to an LLC and a C corporation, it protects shareholders’ personal assets from liability in case a corporation is unable to pay its debts. This is possible because, like a C corporation, an S corporation is a separate legal entity that is distinct from its shareholders. Despite this, shareholders still pay certain taxes.

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In an S corporation, however, taxes work differently. Unlike C corporations, where corporate taxes are involved, taxes, as well as income, losses, and other transactions for an S corporation are passed through directly to shareholders, instead of incurring a separate, additional corporate tax.

Thus, an S corporation is not subject to the double taxation that C corporations are susceptible to, which also means that they are taxed less than other types of businesses, and which in return, leads to substantial tax savings. This could prove beneficial for even smaller businesses like businesses related to YouTube Channels and AikBNB, although there exist some taxes that must be paid, such as income, and sales.

The paper on the right is an actual tax form for an S corporation; form 1120-S, from the IRS.

While C corporations aren’t restricted by the number of shares it can offer, S corporations, on the other hand, are only allowed up to 100 shares, thus having a maximum of 100 shareholders. Moreover, only one class of share can be issued to shareholders, and the S-corp shareholders must be US residents. These restrictions are set forth by IRS regulations. Hence the preference for C corporations over S corporations when it comes to investing. They still have similar access to investment, albeit on a lower level.

However, an S corporation may not be as financially strong as a C corporation. Unlike C corporations, S corporations have lower cash reserves as income taxes are incurred upon their shareholders, which they are obliged to pay. Also, insurance coverage is not available as a tax-free benefit to shareholders who hold a greater stake in the company. And despite being an S corporation, sales taxes may be imposed even to a period prior to filing as an S corporation.

But despite the drawbacks of running an S corporation, the business model is an adequate introduction to the corporate world, and can somewhat strengthen a company’s presence in the local area in which it runs its business operations.

All in All…

The S corporation model is something that smaller companies could benefit from, as taxes aren’t as significant compared to C corporations. However, IRS restrictions and limitations could inhibit further growth and expansion.

An S corporation can later file as a C corporation (you can also use incorporation services such as Northwest Registered Agent and LegalZoom) when circumstances are in favor, and can reap the benefits of a more-established corporation with a stronger business presence.