The difference between S corporation and corporation is that, unlike traditional C corporations, the S corporation is a flow-through entity that does not pay corporate tax to the IRS. Owners of S corporations are thus likely to save on federal taxes. S corporation tax treatment is available to qualified corporations and can be obtained by filing Form 2553 to the IRS.

S Corporation or Corporation: Which One Will You Choose?

The choice between the two taxation entities will come down to your goals. S corporations are, in reality, corporations or LLCs, and therefore, their owners have limited liability protection just like the shareholders of C corporations. Qualified corporations and LLCs whose owners have decided to have the business taxed as an S corporation can do so by filing IRS Form 2553.

The S corporation gets its name from Subchapter S of the Internal Revenue Code which regulates it. The main differences between businesses taxed as S corporations and those taxed as corporations are discussed below.

S Corporations Vs C Corporations: Taxes

Corporate Tax

The most obvious advantage S corporations have over C corporations is that, while C corporations are required to pay federal corporate tax on their profits, businesses taxed as S corporations don't pay federal corporate tax. They are regarded as pass-through entities whose profits are forwarded directly to the owners. It is the owners of the company who are required to pay personal income tax on their earnings as is the case with shareholders of C corporations. In theory, this means that the owners of C corporations will lose more of their earnings to taxes than owners of S corporations. But, in practice, it is not always the case.
C corporations file tax returns using IRS Form 1120. Businesses taxed as S corporations file a similar return using Form 1120S, but this is for information purposes only. Taxes are not levied on S corporations.

State Taxes

Several states use an approach similar to the one of the IRS when dealing with businesses that are taxed as S corporations. Such states don't levy corporate taxes on S corporations. But some states treat S corporations the same way they treat traditional corporations and collect corporate tax from S corporations as well as income tax from S corporation shareholders

Taxes on Insurance Benefits

The C corporation arrangement enables the business to offer health insurance, life insurance, and disability insurance to most of its employee shareholders without paying taxes on those benefits. The corporation can deduct the cost of such benefits from the taxes provided so that it's the business' policy to give those benefits to 70 percent or more of its employees. Employee shareholders of S corporations have to pay any taxes resulting from fringe benefits unless they own less than 2 percent of the company.

Shareholders and Members

Perhaps the most important advantage traditional corporations have over the S corporation arrangement is the lack of restrictions on ownership. 

  • While the ownership of an S corporation is limited to 100 shareholders, there are no such restrictions on C corporations.
  • S corporations cannot have shareholders who are not US citizens or US residents, but C corporations can have shareholders from most countries in the world.
  • C corporations stock can be held by entities. This includes trusts, LLCs, partnerships, and other corporations. This is prohibited by law for S corporations.
  • S corporations are also restricted to having no more than one class of stock. Many C corporations, on the other hand, have been able to grow by drafting in an inferior class of shareholders with limited rights.

You can find an in-depth description of the differences between S corporations and C corporations in our detailed article. The differences discussed above show that large-scale businesses are forced to file and function as traditional C corporations. The S corporation arrangement may offer benefits to some small and medium businesses. However, not all small businesses would benefit from the S corporation. It is important to discuss the pros and cons of each business type with a good CPA and tax lawyer in your state.

If you need help to choose between the S corporation and the C corporation, 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.