Planning on establishing a corporation but can’t decide whether to incorporate as a Delaware S Corp vs C Corp? This blog is a can’t miss reference for all investors.
1. Delaware corporation: A brief introduction
Delaware corporation is a type of business entity that is incorporated in the state and can conduct its business anywhere else.
This entity type was first adopted in the late 1980s due to the need to attract more investments outside of the state. Gradually, Delaware becomes one of the most prestigious places to incorporate despite the fact that most of the incorporated ones conduct business outside the state.
To get more in-depth information, read our Delaware Corporation blog now!
2. Delaware S Corp vs C Corp: Quick comparison
If you decide to opt for Corporation in Delaware, you will have to face a big question: “Will it be S-Corporation or C-Corporation?”. Below are the main differences between these two types.
2.1 Incorporation process
The most conspicuous difference between S Corp vs C Corp is the incorporation process.
In terms of C Corp, when you form a corporation in Delaware, C Corp is the default type. Let’s put this in a simple way. You file the articles of incorporation in order to register for your corporation, your company will be recognized as a C-Corporation.
However, if your wish is to operate as an S-Corporation, you must file an additional IRS Form 2553. Most business owners file this form and become an S Corp because of federal tax purposes. In order to be treated as an S Corp in Delaware, you will need to file additional documentation.
Besides having to deal with extra paperwork, the incorporation of a C Corp and an S Corp is the same. You will need to proceed through the same steps to form a Delaware corporation. For a detailed explanation, check out How to form a Delaware corporation now!
C Corp vs S Corp, each has distinct taxation. Most investors go with the S Corp structure to save money on taxes. Let’s break this down!
C Corp Taxation. Also known as a regular corporation, C Corp is taxed as a separate entity in Delaware. It is obligated for C Corp to file Form 1120 to report its income and claim its deductions as well as credits annually at the federal level.
An important note is that a C Corp is taxed again on the shareholder’s individual income tax if the income is distributed as dividends. It is known that C Corp is subject to “double taxation”.
The only way out of this double taxation is to operate your business at a loss or reinvest profits into the business. Regardless, C Corp is now subject to a flat 21% business tax rate at the federal level and 8.7% at the state level, no matter what its income and size are.
Though being offered a great deal of tax cut, you still can’t avoid double taxation as a C Corp.
C Corp can be the ideal solution if your company is in a developing stage and your plan is to finance all the profit back into the business’s fund.
S Corp Taxation. As mentioned above, S Corp is mainly formed for federal tax purposes. Once you finish registering for a corporation, you can change your company to an S Corp by filing an election using Form 2553.
By this election, all the income and losses of the S Corp will be passed to the shareholders. These shareholders have to report their shares of the business’ income and losses on their individual tax returns.
What’s more? To fiscally transparent entities namely LLC, sole proprietorship, partnership, and S Corp, its owners can deduct 20% of qualified business income. But then again, this deduction will expire in 2025 unless the government decides to extend the law.
Let's examine a quick example!
Your S Corp in Delaware earns USD100,000 in 2021. You could deduct 20% of your company’s income and pay taxes on the USD80,000.
A small note for those who are interested in this deduction plan:
- Which type of businesses are qualified to deduct changes yearly based mainly on inflation.
- In 2020, S Corps with less than USD163,300 (single filers) or USD326,600 (married filers) in annual income can make use of this deduction. These thresholds will be changed annually.
- If the income of your company is above the mentioned thresholds, the deduction will be limited by the number of wages that you pay your staff.
One last significant difference is the ownership of Delaware S Corp vs C Corp. To make it simpler, there is a huge difference in terms of flexibility between these two types of Delaware corporations.
C Corp. When it comes to flexibility, C Corp is definitely the winner. There are completely no restrictions on the ownership of C Corp. The number of shareholders is unlimited. The same applies to different classes of shareholders. Plus, shareholders of a C Corp can be both natural persons or other companies. Thanks to this characteristic, raising funds with a C Corp is no sweat.
Another perk is that C Corp can be owned by other entities such as Corporation, LLC, or Trust. It might come in handy if you wish to sell your business to pursue other passions.
S Corp. Divergent from C Corp, S Corp can have no more than 100 shareholders. Thus, all of the shareholders have to be natural person which is not a foreigner. Another big note to keep in mind, only US residents can form an S Corp in Delaware.
3. Delaware S Corp vs C Corp: Which one
In order to come to a conclusion on which corporation suits you the best, try answering the following questions:
Do you have any plan of acquisition in the future?
If you think one day you might sell your business to have more funds to pursue another direction, then it’s best to stay with C Corp. As mentioned earlier, only C Corp can be owned by other entities.
How many shareholders are there in your company?
You are a small business, and you are happy that way. Perhaps S Corp is perfect for you. However, if you plan to expand your business in the near future, C Corp will be a top-notch choice.
Is double taxation worthwhile?
It is undeniable that between Delaware S Corp vs C Corp, C Corp has to face double taxation as there is a corporate tax to deal with. If handling double taxation is not a big obstacle to you, then C Corp won’t be a problem. But, if your goal is to get rid of the corporate tax, S Corp – as a fiscally transparent entity, is the best match for your business.
Do extra paperwork and caution sound good to you?
In order to become an S Corp, you will have to go through additional steps with the IRS. But it does not end there. Operating business as an S Corp will put your company in the eyesight of the IRS. You have to be extra careful and try to keep your record as pristine as it can be.
Above are the make-or-break issues that you need to thoroughly consider before opting for either C Corp or S Corp. Besides these crucial questions, you also have to contemplate other aspects: your capital, business field, size, etc.
Delaware S Corp vs C Corp offers distinct perks to business owners. If Delaware is your dream incorporation destination and the corporation is the entity you are after, then considering the issues that arise in this blog is essential.