Many small business CPAs champion the S corporation over the C corporation. An S-corporation enables you to pull the money out of your company via dividends or similar distributions and avoid the double taxation of C corporations. With a C corporation, the corporation pays taxes at the corporate rate then, as the owner, you are taxed at your personal tax rate on any dividends or distributions the corporation pays you. This double tax avoidance is the primary reason so many small business CPAs strongly endorse S corporations over C corporations.
However, many situations exist for which C corporations can be better than S Corporations. What are some of these situations? It depends on what you are trying to achieve. Virtually every business that goes public via an IPO is a C Corporation. Rapidly growing companies seeking outside investors prefer to operate as C corporations due to the abundance of case law that exists and the lack of restrictions on who the investors can be.
For example, LLCs and corporations can NOT invest in S Corporations but these entities can exist in C Corporations. In addition, S corporations can only have a maximum of 100 shareholders while the number of shareholders for C corporations is unlimited. As the number of investors increases, the tax preparation becomes increasingly more complex since your company or its external accountants must prepare Schedule K-1s for each and every investor!
If you are fortunate to own and operate a highly profitable company, you may wish to hold more money in your corporation and refrain from distribution to yourself and other shareholders. You and your investors may want to use that money to build the company organically or through acquisitions. However, with an S corporation you pay taxes on the company’s net income whether or not you physically take distributions of the funds. In addition, most investors your company will target to raise funds from who are not associated with the company are considered high net worth individuals. Many of these individuals want to avoid being taxed on significant distributions each year.
One additional benefit of C corporations over S corporations? The IRS has specific rules governing tax treatment of perks and income for S corporation owner-operators. This tax treatment of perks and income can become complicated. Of course, this is one reason that a small business / private company CPA firm is so valuable. These firms will wade through the concerns and help you structure your S corporation’s perks and income distribution accordingly. Of course, the tax treatment of these same perks and income for C corporations is more straightforward. (For more information, refer to my previous article, Bonus and Dividends in a Subchapter S corporation.)
If your company is at break even or not very profitable, will not be used as an acquisition vehicle to buy other businesses, and will not raise funds from numerous investors or entities operating as legally separate companies, then you can maintain your company’s operation as an S corporation. If the S company status no longer works for you for the reasons specified above, then you can revoke your company’s S Corporation status by formally notifying the IRS. Remember, an S corporation is solely a designation determined by the IRS. The IRS places the restrictions on S corporations which you can remove through formal revocation. For more information on S corporation requirements and revocation, refer to the references below.