Key Takeaways

  • The main difference between S Corp and C Corp lies in taxation: S corporations are pass-through entities, while C corporations face double taxation.
  • S Corps can have up to 100 shareholders and only one class of stock, while C Corps can have unlimited shareholders and multiple stock classes.
  • S Corp shareholders must be U.S. citizens or residents; C Corps can include foreign and institutional investors.
  • C Corps are ideal for larger or fast-growing businesses seeking venture capital; S Corps work better for small or family-owned companies.
  • Both offer limited liability protection, but compliance and recordkeeping requirements can differ.
  • Converting between the two requires IRS approval and can have tax implications.

The difference between S and C Corps is that S-Corp owners are taxed once by the federal government, whereas C-Corp owners are subjected to double taxation. In terms of ownership, businesses treated as S corporations can only have a maximum of 100 owners who are individual US citizens or residents. C-Corps can have different types of shareholders, including US or non-US citizens and entities. 

The Business Owner's Dilemma: S Corporation or C Corporation?

The S Corporation is not an entity type, but a tax classification that the IRS can bestow on certain LLCs and corporations. Therefore, C-Corps and S-Corps have similar initial formation procedures. They must file the relevant documents with the state. New Corporations are, by default classified as C Corporations. LLCs and corporations that desire to be classified as S corporations communicate their desire to the IRS using Form 2553.

Whether to register a business as an S corporation or a C corporation is a question many potential and current business owners ask. It is important to make the right decision because the decision will likely have wide-ranging implications for the business. Generally, large corporations are better off as C-Corps but smaller and medium-sized business can get some benefits by being taxed as S-Corps. If you want to start a bank or insurance company, the decision has already been made for you: IRS guidelines do not allow such businesses to be treated as S corporations. The differences between S corporations and C corporations are discussed below.

Ownership

  • Number and Type of Owners
    The law prevents most big corporations from requesting S-Corp treatment. This is because the ownership of S-Corps is limited to a maximum of 100 individuals who are US citizens or US residents. S-Corps are also not allowed to have most trusts, partnerships, or corporations as owners. C-Corps can have any number and type of shareholders including non-US persons and entities. 
  • Rights of Shareholders
    The flexibility of ownership of C-Corps is extended even to shareholders. While S-Corps can have only one class of stock, C-Corps can have a variety of shareholder categories with different voting powers. This flexibility can make it easier for founding members to allow new shareholders to be drafted in to bring the money needed to grow the business. 

Management and Structure

Both S corporations and C corporations have similar management structures—they operate under a board of directors that oversees major company decisions, while officers handle daily operations. However, the difference between S Corp and C Corp appears in the level of flexibility and shareholder rights.

S corporations typically have tighter ownership restrictions and must follow more rigid IRS requirements to maintain S election status. C corporations, in contrast, have greater flexibility to issue various classes of stock and attract venture capital investors. This makes them the preferred option for startups planning to scale or go public.

Additionally, S corporations must adhere to proportional ownership rules—each shareholder’s income and loss allocation is tied to their ownership percentage. C corporations can structure share classes differently, allowing for preferred shareholders with different voting and dividend rights.

Taxation

  • Double Taxation
    Most people are aware of the double taxation situation in C-Corps which is not available in S-Corps. It is true that C-Corps must pay corporate taxes in addition to income tax on the dividends of individual shareholders. S-Corps, on the other hand, are not subject to corporate tax and this might enable their owners to keep more money after income tax. Enabling owners to avoid double taxation is not the only tax advantage of S-Corps.
  • Loss Compensation
    Owners of new corporations that will be operating at loss for the first years can get another tax benefit from choosing to have the corporation taxed an S-Corp. The owners can use their share of the losses arising from the S Corporation to offset personal incomes obtained elsewhere on their personal income tax returns. This can reduce the owners' individual tax burdens. This provision is not available to C-Corp owners.
  • Selling the Business
    A business sold as an S corporation will likely attract fewer taxes compared to a similar business sold as a C corporation.
  • Health, Life, and Disability Insurance
    One of the tax benefits available to C-Corp shareholder-employees is that the C corporation can deduct the cost of benefits like health, life and, disability insurance from their taxes. This provision is available to corporations that extend out such benefits to 70 percent or more of its employees. S-Corp owner-employees can not deduct the value of such benefits from taxes.

While it is true that big corporations and most small businesses with high-growth goals will only thrive if they are treated as C-corps for tax purposes, not all small and medium-sized businesses need to request for S-Corp treatment. The decision about entity election should be made after a thorough analysis of the tax, ownership, and legal implications. Professional tax lawyers in your state can help you come to the right decision.

Filing Requirements and Forms

When it comes to filing, both S and C corporations must file annual returns, but the forms differ. C corporations file Form 1120 (U.S. Corporation Income Tax Return) to report corporate income and pay federal taxes directly. S corporations, as pass-through entities, file Form 1120-S (U.S. Income Tax Return for an S Corporation) and issue Schedule K-1 to shareholders to report their share of income, deductions, and credits on personal returns.

S corporations also need to submit Form 2553 to the IRS to elect S corporation status, while C corporations do not need this additional filing. Missing or late S election submissions can cause the IRS to treat the business as a C corporation, resulting in double taxation.

C corporations must also manage estimated quarterly tax payments and potential state-level corporate taxes, while S corporations may still face state franchise taxes or minimum fees, depending on the state.

Advantages and Disadvantages Comparison

When deciding between S Corp vs C Corp, business owners should weigh key advantages and disadvantages:

S Corp Advantages:

  • Avoids double taxation (profits pass directly to shareholders).
  • Owners can offset other income with business losses.
  • Offers limited liability protection.
  • Easier transfer of income to shareholders for tax purposes.

S Corp Disadvantages:

  • Ownership limited to 100 shareholders.
  • Only one class of stock permitted.
  • Nonresident aliens, partnerships, and corporations cannot be shareholders.
  • Must pay reasonable salaries to owners before profit distributions.

C Corp Advantages:

  • Unlimited shareholders and multiple stock classes.
  • Easier to attract investors and issue employee stock options.
  • Company retains profits for reinvestment at a fixed 21% corporate tax rate.
  • Broader range of tax-deductible fringe benefits for employees.

C Corp Disadvantages:

  • Subject to double taxation (corporate and individual dividend taxes).
  • Requires more complex reporting and compliance.
  • Accumulated earnings may trigger additional taxes.

Choosing Between S Corp and C Corp

The best structure depends on the business’s goals, size, and growth plans. A small or medium-sized company that prefers simple taxation and fewer shareholders may benefit from S corporation status. In contrast, a growing business seeking external investment or planning to go public will likely prefer the C corporation model.

If your business expects to retain earnings for expansion, a C Corp may provide long-term tax efficiency due to the flat corporate tax rate. But if you plan to distribute most profits annually, an S Corp can reduce tax liability through pass-through taxation.

Business owners should also consider state laws, as not all states recognize S corporations for state tax purposes. Consulting a tax professional or business attorney is crucial before electing or converting between statuses.

Converting from C Corp to S Corp (and Vice Versa)

A corporation can convert from C Corp to S Corp by filing Form 2553 with the IRS, but certain eligibility criteria must be met, such as shareholder limitations and citizenship requirements. The election must be made within 2 months and 15 days after the start of the tax year for which it applies.

Reverting from S Corp to C Corp is also possible but can lead to complex tax implications, including built-in gains tax on appreciated assets. Once revoked, businesses must typically wait five years before reapplying for S corporation status unless granted IRS consent.

It’s important to analyze projected income, ownership plans, and business objectives before making any change, as conversions can trigger unforeseen tax events.

Frequently Asked Questions

  1. What is the main difference between S Corp and C Corp?
    The primary difference lies in taxation. S Corps are pass-through entities, meaning profits are taxed only at the individual level, while C Corps face double taxation on corporate income and dividends.
  2. Can a C Corp become an S Corp later?
    Yes, a C corporation can elect S Corp status by filing Form 2553 with the IRS if it meets all eligibility requirements, including shareholder limits.
  3. Which is better for a small business—S Corp or C Corp?
    Most small businesses prefer S Corps to avoid double taxation and simplify reporting, while C Corps are better for companies planning to attract investors or go public.
  4. Do both S Corps and C Corps offer limited liability protection?
    Yes. Both structures provide limited liability, meaning shareholders are generally not personally liable for corporate debts or legal obligations.
  5. How are S Corp and C Corp shareholders paid?
    S Corp shareholders can receive salaries and profit distributions. C Corp shareholders typically earn salaries if they are employees and dividends as investors.

If you need help in difference between s corp and c corp, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.