Choosing the right corporate structure is one of the first—and most important—decisions a business owner makes. In a recent conversation, Shawn McClelland and Alexa La Barbiera of Mandelbaum Barrett PC’s Corporate Practice Group discuss the key differences between C Corporations and S Corporations, and how those differences can affect everything including taxation, shareholder rights, and raising capital.
Tax Treatment
One of the most significant distinctions between the two structures lies in how they are taxed. A C Corporation is taxed as a separate legal entity, meaning it pays corporate income tax on its earnings. If the company then distributes profits to shareholders as dividends, those individuals are taxed again on that income, resulting in what is commonly referred to as double taxation.
By contrast, an S Corporation is considered a pass-through entity for federal tax purposes. Instead of being taxed at the corporate level, income and losses are reported directly on the shareholders’ individual tax returns. This single layer of taxation is often an advantage for closely held or family-owned businesses
Shareholder Limitations
Another important consideration involves shareholder eligibility and limitations. C Corporations are generally more flexible in this regard—they can be owned by individuals, corporations, partnerships, and even foreign entities. There is no cap on the number of shareholders, which can make them more appealing to businesses seeking to grow quickly or attract broad investor participation.
S Corporations, on the other hand, are more restrictive. They are limited to 100 shareholders and can only be owned by U.S. individuals or certain types of qualifying trusts and estates. These limitations can present challenges when a business is looking to expand its investor base or transfer ownership across entities or family structures.
Stock Structure and Investment Potential
From a capital-raising standpoint, C Corporations offer greater flexibility. They can issue multiple classes of stock, allowing companies to offer preferred shares or tailor investment terms to suit private equity firms, venture capital investors, or other strategic partners. This flexibility is often a decisive factor for founders who anticipate needing outside investment.
In contrast, S Corporations must maintain a single class of stock. All shareholders must be treated equally in terms of distributions. This can limit a company’s ability to structure complex investment deals or offer differentiated incentives to early backers or key employees.
Start with the Right Structure
The choice between a C Corporation and an S Corporation isn’t just a matter of paperwork—it’s a strategic decision that should align with a company’s business model, growth trajectory, and investor landscape.
