S-Corp and C-Corp are both corporation tax classifications, but they’re taxed very differently. The choice comes down to double taxation vs. ownership restrictions.
Quick answer: S-Corps avoid double taxation (profits taxed once, on your personal return) but have ownership restrictions (100 shareholders max, one stock class, no foreign owners). C-Corps face double taxation but have no ownership restrictions and are required for venture capital. Most small businesses prefer S-Corp; funded startups need C-Corp.
S-Corp vs. C-Corp: Side-by-Side
| Feature | S-Corp | C-Corp |
|---|---|---|
| Taxation | Pass-through (single tax) | Double taxation |
| Federal corporate tax rate | N/A (individual rates) | 21% flat |
| Dividend tax | N/A (distributions already taxed) | 0-23.8% on distributions |
| Maximum shareholders | 100 | Unlimited |
| Shareholder types | U.S. individuals, some trusts/estates | Anyone (individuals, entities, foreign) |
| Stock classes | One class only | Multiple classes (common, preferred) |
| Self-employment tax on distributions | No | N/A (salary subject to payroll tax) |
| Retained earnings tax advantage | No (taxed to owners regardless) | Yes (21% rate vs. personal rates) |
| VC/institutional investment | Very rare | Standard |
| IPO eligible | Must convert to C-Corp | Yes |
| QSBS exclusion | No | Yes ($10M+ tax-free gains) |
| Employee stock options (ISOs) | Yes (limited) | Yes (standard) |
Tax Comparison: $200,000 Net Profit
S-Corp Taxation
| Item | Amount |
|---|---|
| Net business profit | $200,000 |
| Reasonable salary (W-2) | $85,000 |
| Payroll taxes on salary | $12,750 (both halves) |
| Distribution (not payroll taxed) | $115,000 |
| Income tax on $200,000 (combined) | ~$42,000-$55,000 (varies by total income) |
| Total tax burden | ~$55,000-$68,000 |
C-Corp Taxation (Fully Distributed)
| Item | Amount |
|---|---|
| Net business profit | $200,000 |
| Corporate tax (21%) | $42,000 |
| After-tax profit | $158,000 |
| Owner salary | $85,000 (deducted before profit) |
| Dividend tax on $158,000 (23.8%) | $37,604 |
| Payroll taxes on salary | $12,750 |
| Total tax burden | ~$92,354 |
C-Corp Taxation (Retaining All Earnings)
| Item | Amount |
|---|---|
| Net business profit | $200,000 |
| Corporate tax (21%) | $42,000 |
| Owner salary | $85,000 (deducted before profit) |
| Payroll taxes on salary | $12,750 |
| Dividend tax | $0 (no distribution) |
| Total tax burden | ~$54,750 |
Key insight: C-Corps are tax-efficient when retaining earnings. They’re tax-inefficient when distributing profits.
S-Corp Eligibility Restrictions
| Restriction | Details |
|---|---|
| Maximum shareholders | 100 (family members can count as one) |
| Shareholder types | U.S. citizens/residents, certain trusts, estates |
| Foreign owners | Not allowed |
| Entity owners | No corporations or partnerships as shareholders |
| Stock classes | Only one class of stock (voting rights can vary) |
| Tax year | Must use calendar year (exceptions exist) |
| Certain businesses excluded | Banks, insurance companies, DISCs |
When to Choose S-Corp
| Situation | Why S-Corp Works |
|---|---|
| Small business, 1-100 owners | Avoids double taxation |
| Profitable business distributing earnings | Single-level tax on all profit |
| Service business (consulting, professional) | Pass-through + SE tax savings on distributions |
| All U.S. owners | Meets eligibility requirement |
| No plans for VC funding | No investor stock class needs |
| Steady, distributable income | Maximizes single-tax benefit |
| Owner wants to minimize total tax | Pass-through typically lower total burden |
When to Choose C-Corp
| Situation | Why C-Corp Works |
|---|---|
| Raising venture capital | VCs require preferred stock (multiple classes) |
| Planning IPO or acquisition | Standard corporate structure required |
| Retaining significant profits | 21% rate vs. 37% top personal rate |
| Foreign investors or owners | S-Corp doesn’t allow foreign shareholders |
| More than 100 investors | S-Corp limit is 100 |
| QSBS tax strategy | $10M+ potential tax-free gains on sale |
| Employee stock option plans | ISOs standard in C-Corps |
| Reinvesting heavily for growth | Low corporate tax rate on retained earnings |
Compliance Comparison
| Requirement | S-Corp | C-Corp |
|---|---|---|
| Tax return | Form 1120-S | Form 1120 |
| K-1s to shareholders | Yes | No (1099-DIV for dividends) |
| Reasonable salary requirement | Yes (for shareholder-employees) | Yes (for employees) |
| Board of directors | Required | Required |
| Board meetings | Required (annual) | Required (annual) |
| Meeting minutes | Required | Required |
| Stock ledger | Required | Required |
| Annual state filings | Required | Required |
| Estimated tax payments | Quarterly (personal) | Quarterly (corporate) |
Converting Between S-Corp and C-Corp
C-Corp to S-Corp
| Step | Details |
|---|---|
| File Form 2553 | Must be filed by March 15 for current year |
| Meet all S-Corp requirements | 100 shareholders max, one stock class, etc. |
| Built-in gains tax | 5-year recognition period on appreciated assets |
| Accumulated E&P | May trigger tax on distributions |
S-Corp to C-Corp
| Step | Details |
|---|---|
| Revoke S-election | File statement with IRS |
| Effective date | Can choose prospective date |
| 5-year waiting period | Cannot re-elect S-Corp for 5 years |
| Common reason | Preparing for VC funding or IPO |
Bottom Line
S-Corp is better for most small businesses — it avoids double taxation and saves on self-employment tax for owner-distributions. C-Corp is better for funded startups — required for venture capital, enables QSBS tax-free gains, and is tax-efficient when retaining all earnings at the 21% corporate rate. If you’re unsure, start with an LLC (S-Corp election) — you can always convert to a C-Corp later if you raise institutional funding.
Related: LLC vs. S-Corp | LLC vs. C-Corp | LLC vs. Sole Proprietorship | How to Start a Business
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