Key Takeaways

  • C Corps are taxed twice—once at the corporate level and again when dividends are distributed to shareholders.
  • S Corps avoid double taxation through pass-through taxation, where income and losses flow directly to shareholders’ personal tax returns.
  • C Corps can have unlimited shareholders and multiple stock classes, while S Corps are limited to 100 U.S. shareholders and one class of stock.
  • S Corp owners must pay themselves a reasonable salary subject to payroll taxes, while the remaining profits can be distributed as dividends to reduce tax liability.
  • C Corps can retain earnings and offer broader employee benefits, which may be advantageous for larger or growing businesses.
  • Choosing between structures depends on tax strategy, ownership goals, and growth potential—consult a tax professional or business attorney to determine the best fit.

C corp vs S corp taxes refers to the differences between being taxed as a C corporation or an S corporation by the IRS. A C corporation is the most common US corporation, and the type of corporation that all businesses begin as. S corporations, on the other hand, are formed by filing Form 2553 with the IRS in what is known as a status election. The most common reason for taking an S corp election is for the tax treatment that many find favorable.

C Corps and S Corps

Choosing between a C corp and an S corp is one of the most important decisions a new business owner must face, with many ramifications both tax related and otherwise. Thus, including an attorney and a tax professional in this decision may be advisable.

Similarities Between C Corps and S Corps

There are many similarities between C corps and S corps, including:

  • Limited liability protection. Both S corps and C corps offer limited liability protection, meaning that in most cases the owners do not bear personal responsibility for business liabilities and debts.
  • Structure. Both corporation forms must have directors, officers, and shareholders. The shareholders are also known as the owners and these individuals choose directors who manage big-picture issues. Officers are chosen to run the day-to-day affairs.
  • Formalities. S corps and C corps are both required to adhere to the same external and internal obligations and formalities, such as issuing stock, adopting bylaws, filing annual reports, paying annual fees, and holding director and shareholder meetings.
  • Payroll requirements. All owners who work for the corporation must be on the payroll. Payroll taxes are to be withheld and matched, and all working owners should be given a reasonable rate of pay since the IRS looks at pay rates closely to see if taxes are avoided by taking an abnormally low salary.
  • Perpetual existence. What is called “perpetual existence” applies to both S and C corps. Perpetual existence means that an S or C corp will continue on regardless of the owner’s involvement or health status, including if they should pass away.

Differences Between C Corps and S Corps

The corporations do have many similarities, but C corps and S corps also have differences, including:

  • Tax level. C corporations must pay taxes on the corporate level, while S corporations have their losses or profits pass through to the individual shareholders, who are then taxed individually. In this system, S corporation losses get applied to other income, which reduces the shareholder’s tax liability.
  • Fund withdrawal. Owners of C corporations cannot withdraw funds arbitrarily, and funds that are withdrawn are subject to double taxation. Owners of S corporations, on the other hand, may withdraw funds as long as they are paid wages by the S corporation.
  • Benefits. C corporations enjoy more benefits than S corporations, such as disability and life insurance, and these benefits are not taxed so long as at least 70% of those in the corporation receive those benefits.
  • Estimated tax. C corps pay estimated tax based on their total profit, while S corps pay this on the state level based on the state rules that apply.
  • Income tax. S corporations pay no income tax on the federal level, while C corporations do.
  • Ownership restrictions. C corporations have unrestricted ownership, while S corps cannot have over 100 shareholders, nor any shareholders who are non-US citizens, LLCs, partnerships, other S corporations, C corporations, or many trusts.
  • Stock. C corporations can have multiple classes of stock, while S corporations can only have one.

How C Corp and S Corp Taxes Work

The biggest distinction in the S Corp vs C Corp taxes comparison lies in how income is reported and taxed.

C Corporations are considered separate tax entities and file their own corporate tax returns using IRS Form 1120. Profits are taxed at the federal corporate rate of 21%, and when these profits are distributed to shareholders as dividends, they are taxed again on the shareholders’ individual returns—commonly known as double taxation. However, C Corps can retain earnings within the business for reinvestment, potentially reducing taxable distributions and fueling long-term growth.

S Corporations, on the other hand, file an informational return using Form 1120-S, but the entity itself generally pays no federal income tax. Instead, income and losses are passed through to shareholders and reported on their personal returns using Schedule K-1. This setup helps avoid double taxation and can reduce overall tax liability, especially for small to mid-sized businesses.

While this may seem like an obvious advantage, S Corps must adhere to strict IRS requirements:

  • They can have no more than 100 shareholders.
  • All shareholders must be U.S. citizens or residents.
  • Only one class of stock is allowed.

Failure to meet these criteria may cause an S Corp to revert to C Corp status and lose its tax benefits.

Taking the S Corp Election

If you do decide to take the S corp election, you will have to make sure that your business meets the ownership restrictions for S corps, and then, if it does, you will have to file Form 2553 with the IRS. This form should be filed before two months and fifteen days of the tax year have passed. Additionally, it is a requirement in some states that you file an S corp election on the state level.

Tax Planning Tips for S Corps and C Corps

Understanding the nuances of S Corp vs C Corp taxes can help reduce your overall tax burden. Consider these strategies:

  1. For S Corps:
    • Pay yourself a reasonable salary to satisfy IRS requirements and reduce audit risk.
    • Track and document shareholder distributions carefully to ensure compliance.
    • Use shareholder loans or retained earnings strategically to manage cash flow.
  2. For C Corps:
    • Reinvest profits into the business to delay personal taxation.
    • Offer tax-advantaged employee benefits, such as health insurance and retirement plans.
    • Consider setting up a holding company to optimize taxation on subsidiaries or multiple business ventures.

Ultimately, the right tax approach depends on your business size, ownership structure, and long-term goals. You can consult an experienced attorney through UpCounsel’s marketplace to help determine whether C Corp or S Corp taxation best fits your strategy.

Choosing Between an S Corp and a C Corp

When deciding between these corporate structures, consider both short-term tax impact and long-term business goals.

You might choose a C Corporation if your business plans to:

  • Reinvest profits to fuel growth rather than distribute them.
  • Seek venture capital or institutional investors (since C Corps allow multiple stock classes).
  • Offer comprehensive benefits such as health insurance and retirement plans, which are typically tax-deductible for the corporation.

An S Corporation may be more beneficial if you want to:

  • Minimize self-employment taxes through a combination of salary and distributions.
  • Simplify taxation by reporting profits and losses directly on your personal return.
  • Operate a smaller business without plans for complex shareholder structures.

Many business owners also weigh state-level taxation. Some states impose corporate income tax on both S Corps and C Corps, while others, like Texas and California, apply franchise or entity-level taxes even to S Corps. Consulting a qualified attorney or accountant ensures that your choice aligns with both federal and state tax regulations.

Frequently Asked Questions

  1. What is the main tax difference between S Corps and C Corps?
    C Corps face double taxation—corporate income is taxed at 21%, and dividends are taxed again on personal returns. S Corps use pass-through taxation, avoiding corporate-level taxes.
  2. Can an S Corp deduct business expenses?
    Yes. Both S Corps and C Corps can deduct ordinary and necessary business expenses, such as salaries, rent, and benefits, to reduce taxable income.
  3. Can an S Corp have foreign shareholders?
    No. Only U.S. citizens or resident individuals may own shares in an S Corp. Foreign ownership is only permitted in C Corps.
  4. Is it possible to switch from an S Corp to a C Corp?
    Yes. You can revoke your S Corp election with the IRS, but timing and tax implications should be carefully evaluated to avoid unexpected liabilities.
  5. Which is better for attracting investors—S Corp or C Corp?
    C Corps are typically preferred by investors and venture capitalists because they allow multiple stock classes and do not restrict foreign ownership.

If you need help understanding C corp vs S corp taxes, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.