First Off: What is an S Corp?
If you’re curious about why you would want to be an S corporation, it’s quite simple—less taxes! An S corp has pass through taxation similar to a Limited Liability Corporation (LLC). However, many companies find that an S corp is not right for them because 1) it does not permit more than 100 stockholders, and all of these stockholders must be people (as in natural persons, which excludes most businesses, but can include some trusts), 2) stockholders must be U.S. citizens or U.S. residents, and 3) it can only have one class of stock. However, if these factors are not a deterrent, you might consider choosing such an option.
What’s the Difference Between Forming an S Corp and Forming a C Corp?
Comparing the formation of an LLC and a C corporation is akin to comparing apples and oranges (which is more fully explained in our blog post Business Structures: LLC vs. C Corporation). Think of the difference between forming a Delaware C corp and a Delaware S corp as the difference between an apple and an apple wrapped in caramel. To form an S Corp, you must first form a C corp and then complete some additional work to finish setting it up, the “caramel dip” that differentiates the business structure.
How do you Make an S Corp Election?
Put quite simply, a Delaware S corp is a Delaware C corp with one extra document. If you incorporate a Delaware C corp and file a Form 2553 with the IRS, the IRS will write back to you and tell you that you have a Delaware S-corp on your hands now.
You can read more about a form 2553 on the IRS website (including the time window you have to make such an election) here: https://www.irs.gov/forms-pubs/form-2553-election-by-a-small-business-corporation
Do S Corps Exclude VCs From Being Shareholders?
Most VCs cannot actually invest in an S corp. S corps have shareholder restrictions that only allow “natural persons” (not partnerships like most VCs) to be shareholders. So this means your average VC can’t own shares (which is essential for investing) in an S Corp.
What if I Need to Stop Being an S Corp Because it’s No Longer Right for my Company?
The same way that you can file a form to become an S corp, you can also revoke your S corp status to become a regular Delaware C corp. Usually there is a shareholder consent approving the S corp revocation, and then a letter to the IRS letting the IRS know that the shareholders have decided to terminate its tax status as an S corp.
Whether a Delaware C corp or a Delaware S corp is right for your company is up to you, but hopefully understanding the differences in how they’re set up in the beginning will help you make an educated decision.