When you’re getting a tech company off the ground, you’re faced with a lot of big decisions. From identifying the right funding sources to building your company’s branding, you’re making choices that will affect you from here on out.
That’s particularly true when it comes to the business structure you choose. The path you pick will determine how you get taxed, which investors you can work with, and more. But before you get overly daunted about your business structure options, know that we can help. For starters, we built this guide to walk you through two of the most common options tech startup founders choose: C corporations and S corporations.
Beyond that, we’re also available to consult with you about your business structure. If you want to talk with accounting professionals about what structure will best suit your vision, we’re here.
First, though, it will probably help to get a broad idea of your options. So let’s look at C corps, S corps, and which might be right for your startup.
C corporation 101
At its core, a C corporation is a company taxed separately from its owners. The entity does business and pays taxes on its profits (i.e., income tax). It’s also subject to all of the same employment taxes (Social Security, Medicare, etc.) as other business types in the U.S.
If you ever plan to go public, a C corp structure can make that easier because the sale of stock is already built-in. You can offer stock to any shareholder. When they buy stock, you issue them a stock certificate and they get an ownership stake in the business. The more stock they buy, the greater their stake.
C corps pay taxes on their earnings, then distribute what’s left to their shareholders as dividends. The shareholders’ earnings get taxed as income.
Once it’s established, the C corporation remains in place. That means your startup can change ownership without compromising the business structure, which can make it easier for you to sell.
Pros of C corps
Why do so many tech startups structure as C corporations? Here are some of the major perks:
- Personal liability protection. While you might think an LLC would be the way to shrink liability for you and any shareholders, C corps are actually ideal because they keep the business and anyone’s personal assets entirely separate. That makes startups structured as C corps particularly enticing to investors. The most they can lose is what they invest in the company; their personal assets are completely protected.
- Fundraising opportunity. You can sell stock in your C corp to raise money.
- Hiring enticement. Similarly, you can include stock in your hiring packages as a way to draw top talent to your startup.
- Continual business structure. As your startup scales, owners and investors might choose to leave. With a C corporation, they can simply sell their shares. The business structure stays intact.
- Tax perks. You can deduct certain business expenses and enjoy tax benefits like the R&D tax credit.
- No cap on growth. With a C corp, you can grow without a ceiling. You can have as many shareholders as you want, for example, and should you want to sell, your C corp can be purchased by just about anyone since there are no restrictions around who or what can be a shareholder.
Cons of C corps
Now, let’s look at the potential downsides of C corporations.
- Double taxation. This is the biggest drawback. The corporation gets taxed on its earnings. When profits get distributed to shareholders as dividends, they get taxed on those individuals’ income taxes. All that said, there are several steps a C corp can take to limit its tax liability, and our C corp specialists here at ShayCPA can help.
- Administrative requirements. Exactly what you need to do to form your C corporation gets dictated by your state, but some states come with higher incorporation costs when compared with other business structures. You’ll also be subject to requirements like the need to:
- Form a board of directors
- Hold annual board meetings and publish meeting minutes
- Post company bylaws at your primary place of business
- File annual reports and disclosures (again, we can help)
S corporation 101
S corporations function similarly to C corporations but the IRS sees them as pass-through entities. That means the S corp can pass profits and certain losses onto their shareholders. The shareholders then see that money is taxed according to their personal income tax bracket, but the S corp isn’t responsible for taxes on the passed-through amounts.
All that said, S corps are significantly more limited than C corps, and several of those limitations can be particularly troublesome for tech companies hoping to scale.
Pros of S corps
The highlight of this business structure type pretty much comes down to the pass-through taxation. This helps you avoid the double taxation you see with a C corp.
Cons of S corps
While it might seem enticing tax-wise, tech startups that structure as S corps come up against several roadblocks, including:
- Shareholder limitation. As an S corp, you cap out at 100 shareholders. You can’t grow past the 100-shareholder mark. Additionally, your shareholders have to be “allowable,” which essentially means they can’t be corporations, partnerships, or non-resident aliens.
- IRS paperwork. While you establish a C corp with your state, you have to file with the IRS to establish an S corp.
- Differences in state laws. Some states tax S corps like the IRS, while others treat them like a C corp. That can make filing complex if you have a nexus in multiple states.
- Stock limitation. S corps are only allowed to have one class of stock.
The best business structure for tech startups
Ultimately, because it’s enticing to investors and doesn’t put any limitations on a startup’s growth, we usually recommend structuring as a C corporation. That said, each startup is unique. If you want to talk through your options — and the tax ramifications of each — with tech startup specialists, contact our team at ShayCPA.