Choosing between an S Corp vs C Corp is a crucial decision that affects your tax bill, investor options, and business trajectory for years to come.
The IRS distinguishes these structures under Subchapter S and Subchapter C of the Internal Revenue Code, but differences run deeper than tax forms.
Your choice affects ownership eligibility, capital-raising ability, compliance requirements, and whether you face double taxation or pass-through treatment.
This matters because picking the wrong structure costs tens of thousands in unnecessary taxes or locks you out of venture capital when you need it.
If you’re a small business owner, startup founder, or entrepreneur evaluating corporate structures, you need clear answers on taxation mechanics, ownership restrictions, and strategic fit. This guide compares S corps vs C corps so you can make the right choice for your business goals.
Key Takeaways:
- S corporations avoid double taxation through pass-through treatment, but face strict ownership and stock limitations
- C corporations offer unlimited growth potential and multi-class stock, but pay corporate-level tax on profits
- Your choice depends on tax strategy, fundraising needs, ownership plans, and exit goals
- Both require identical formation processes—the difference is the IRS tax election
What Is a Corporation? (Core Concepts Before Choosing S Corp or C Corp)
A corporation is a legal entity that exists separately from its owners. When you incorporate, you create a business that can own property, enter contracts, sue and be sued, and continue operating even when ownership changes.
This separation gives you limited liability protection—your personal assets stay protected if the business faces debts or lawsuits.
Every corporation starts by filing Articles of Incorporation with its state. These documents create the legal entity and establish perpetual existence, meaning the corporation doesn’t dissolve when shareholders leave.
Directors oversee company strategy, officers handle daily operations, and shareholders own equity but don’t manage directly.
Here’s what most people miss: S corp and C corp aren’t formation types. They’re tax classifications that determine how the IRS treats your corporation’s income. You form one corporation, then elect how it gets taxed.
This distinction matters because you’ll always start with the same formation steps regardless of whether you eventually choose S corp or C corp status.
What Is a C Corporation?
A C corporation is the default corporate tax status. When you incorporate without making another election, you’re automatically a C corporation under Subchapter C. The IRS treats C corps as separate taxpaying entities that file Form 1120 and pay corporate income tax at 21% on profits.
C corps offer maximum flexibility. You can issue multiple stock classes with different voting rights and dividend preferences. There’s no shareholder limit, and owners can be individuals, corporations, partnerships, or foreign investors. This flexibility makes C corps essential for companies raising venture capital or planning to go public.
Typical scenarios include VC-backed startups needing preferred stock, companies planning IPOs, and businesses offering stock to hundreds of employees. The trade-off is double taxation—profits get taxed at the corporate level, then shareholders pay personal income tax on dividends.
What Is an S Corporation?
An S corporation is a pass-through tax election for qualifying corporations. Instead of paying corporate income tax, S corporations pass profits and losses to shareholders who report them on personal returns. You elect this status by filing IRS Form 2553.
S corporations have strict eligibility requirements, which include a Maximum of 100 shareholders, all U.S. citizens or residents with no foreign investors, corporations, or partnerships.
You’re limited to one class of stock, though voting rights can vary. These restrictions exist because Congress designed S corporation status for smaller domestic businesses.
Typical use cases include small businesses with profits over $60,000 where owner-operators want tax efficiency, professional firms like law practices, and home-based businesses generating steady income. Single-taxation benefits make S corporations attractive when distributing profits rather than reinvesting for growth.
Common Qualities Shared by S Corps and C Corps
Both start with an identical formation—tax election comes later.
Limited Liability Protection
Both shield personal assets from business debts and lawsuits. Corporate assets face risk, but your home and savings stay protected with proper formalities.
Separate Legal Entity Status
The corporation exists independently. It owns property, enters contracts, and continues when shareholders change.
Articles of Incorporation Requirements
Formation requires filing Articles of Incorporation with your state. These establish legal existence, name, registered agent, and authorized shares. Filing is identical for eventual S or C status.
Corporate Structure (Shareholders, Directors, Officers)
Both operate through shareholders who own, directors who oversee, and officers who manage daily operations.
Corporate Formalities (Bylaws, Meetings, Minutes, Annual Reports, Fees)
Corporations must adopt bylaws, hold annual meetings, maintain minutes, and file annual reports. State fees range from $50 to $800. Requirements apply equally—tax election doesn’t change compliance. Missing formalities pierce the corporate veil.
Key Differences Between S Corporations and C Corporations
Five core differences determine strategic fit.
Ownership Rules
S corps cap ownership at 100 U.S. citizen/resident shareholders. C corps allow unlimited shareholders of any nationality. This disqualifies S corporations for international investment or public companies.
Stock Classes
An S corporation issues one class of stock—voting rights vary, but economic rights must be identical. C corps issue multiple classes with different dividends and liquidation preferences, enabling preferred stock for investors.
Tax Treatment
C corps pay corporate tax on profits, then shareholders pay personal tax on dividends—double taxation. S corporations avoid corporate tax entirely. Profits flow through to shareholders, who pay personal tax once, saving 15-20% typically.
Foreign Shareholder Limitations
S corporations prohibit foreign ownership. One non-U.S. shareholder terminates your election. C corps welcome foreign investors.
Fundraising Potential
One-class stock and shareholder restrictions make S corporations unsuitable for venture capital. Investors demand preferred stock with protections that violate S corporation rules. C corps structure complex equity arrangements, attracting institutional capital.
S Corps vs C Corps: How Are They Taxed
C Corporation Taxation (Corporate-Level Taxation)
C corporations file Form 1120 and pay 21% federal tax on income. When distributing profits as dividends, shareholders pay personal tax at 0-20% rates.
Double taxation numerically: $100,000 profit pays $21,000 corporate tax, leaving $79,000. Distributed as dividends at 20%, that’s $15,800 in personal tax, leaving $63,200 net. Effective combined rate: 36.8%.
S Corporation Taxation (Pass-Through Treatment)
S corporations file Form 1120S—informational only, no corporate tax. Shareholders receive K-1s showing their income share, reported on personal returns at individual rates.
Basic rules limit loss deductions to your investment plus loans made to the corporation. Losses exceeding the basis carry forward.
Salary vs. Distributions for S Corp Owners
The IRS requires reasonable compensation via W-2 before distributions. Wages face a 15.3% payroll tax; distributions don’t.
In Watson v. United States, an accountant received a $24,000 salary while taking $220,000 in distributions. Courts reclassified $175,000 as wages, imposing back taxes. Reasonable compensation means market-rate pay for your role.
QBI Deduction for S Corps
The Qualified Business Income deduction allows up to a 20% deduction on qualified income. $100,000 profit becomes $80,000 taxable with a $20,000 deduction.
Limitations apply above $232,100 (single) or $464,200 (married) for specified service businesses.
Loss Flow-Through Rules
S corp losses offset other income on personal returns. A $50,000 loss reduces $100,000 wage income to $50,000 taxable. Basis and passive activity rules may limit deductions.
Ownership and Shareholder Restrictions
S Corp Restrictions
S corporations face three constraints: a maximum of 100 shareholders (married couples count as one), only U.S. citizens or residents, and no partnerships, LLCs, or corporations as owners.
These restrictions prevent VC funding, foreign investment, or corporate strategic partners. One violation terminates the S corporation election automatically.
C Corp Flexibility
C corporations accept unlimited shareholders without citizenship requirements. Institutional investors, foreign individuals, partnerships, and corporations can all own stock.
A VC-backed firm needs a C corp structure because funds won’t invest in an S-corp. A family business with three U.S. owners generating steady profits could thrive as an S corporation, saving taxes.
Stock Structure and Capitalization
C Corporations: Multiple Classes of Stock
C corps issue preferred stock with liquidation preferences (investors paid first on exit), convertible securities, and multiple voting classes. VCs demand 1X liquidation preference, anti-dilution protection, and board seats—all structured through preferred stock.
S Corporations: One Class of Stock Rule
S corporations issue one economic class. Voting rights vary, but dividend rights and liquidation preferences must be identical. This eliminates preferred stock.
Without liquidation preferences or anti-dilution rights, sophisticated investors won’t participate. One-class stock works for owner-operators not needing external capital, but blocks traditional VC funding.
Advantages of an S Corporation
- Single taxation—Pay income tax once at the personal level, avoiding corporate tax. Saves 15-20% versus C corps for profitable businesses distributing earnings.
- Lower self-employment tax – Salary-distribution splits save significantly. As a sole proprietor earning $150,000, you pay self-employment tax on all your income. As an S corp paying a $90,000 salary and $60,000 in distributions, payroll tax applies only to salary, saving roughly $9,000 annually.
- Pass-through loss benefits—Early-year losses offset other income immediately rather than carrying forward at the corporate level.
- Easier distribution planning – Pay profits without dividend tax. S corp distributions from previously taxed earnings aren’t taxed again.
Disadvantages of an S Corporation
- Ownership restrictions – Eliminate foreign shareholders and corporate investors. A 100-shareholder cap prevents public offerings.
- Single-class stock – Blocks venture fundraising. Without preferred stock, you can’t offer terms that institutional investors require.
- Growth limits – Can’t raise VC capital or execute an IPO. Limited to bank financing or angel investors.
- Status termination risks—One prohibited shareholder terminates election, creating a surprise C corp conversion with tax consequences.
- Transfer restrictions—Buyers must qualify as eligible shareholders, narrowing your exit market.
Advantages of a C Corporation
- Unlimited ownership – Opens global opportunities. Bring on foreign investors, corporate partners, and scale to millions of shareholders for public offerings. Essential for international competition or aggressive expansion.
- Global investment access—Accept capital from anywhere—international VCs, foreign strategic partners, and overseas individuals. Eliminates artificial barriers to the best capital sources.
- Multi-class stock – Enables sophisticated capital structures. Preferred stock for investors, common stock for founders, options for employees, and convertible securities for bridge financing. These structures align incentives and attract institutional capital.
- Easier scaling – Removes ownership and stock structure constraints. Issue shares to hundreds of employees, accept multiple funding rounds, and execute IPOs when ready.
- QSBS eligibility—Provides powerful exit benefits through Qualified Small Business Stock. Hold C corp stock for five years for up to 100% capital gains exclusion—up to $15 million for stock issued after July 2025. S corps don’t qualify.
Disadvantages of a C Corporation
- Double taxation—Hits distributed profits hard. The 21% corporate tax plus personal dividend tax creates a 36.8% effective rate. This substantially exceeds S corp pass-through rates.
- Stringent governance expectations – Come from institutional investors. Beyond legal requirements, investors demand professional boards, formal committees, comprehensive reporting, and sophisticated governance practices. Compliance burden extends beyond state law.
- Accumulated earnings tax – Arises if retaining too much profit without a documented business purpose. The IRS imposes additional tax on excessive retained earnings, pressuring dividend distributions (which trigger double taxation) or requiring justified retention through documented growth plans.
How to Form a Corporation (Base Structure Before S or C Status)
The formation process follows the same steps regardless of the tax election.
- 1. Choose State of Incorporation: Pick based on business location. Most incorporate in their home state to avoid extra costs. Delaware attracts larger companies but adds fees if not located there.
- 2. Choose a Name: Select a unique name with “Corporation,” “Incorporated,” or an abbreviation. Search the state database. Reserve if not ready to file.
- 3. Appoint Registered Agent: Designate an agent with a physical address in the incorporation state to receive legal documents. Serve yourself or hire a service for $100-300 annually.
- 4. File Articles of Incorporation: Submit to the Secretary of State establishing legal existence—name, agent, authorized shares. Fees range from $50 to $500.
- 5. Draft Bylaws: Create internal governance rules. Not filed, but must be maintained and followed.
- 6. Hold Initial Meeting: Adopt bylaws, elect directors, appoint officers, and approve share issuance. Document in minutes.
- 7. Issue Stock Certificates: Document ownership with certificates and stock ledger tracking issuances, transfers, and cancellations.
- 8. Obtain EIN and Licenses: Apply for EIN using Form SS-4. Register for business licenses and permits.
How to Become a C Corporation
C corp status is automatic—no special filing required. When you incorporate, you’re a C corporation by default under Subchapter C of the tax code.
The IRS expects you to file Form 1120 (U.S. Corporation Income Tax Return) annually and pay corporate income tax on profits.
You only file something if changing from S corp status back to C corp—file a revocation of S corp election or let eligibility terminate (though this creates tax complications).
Track corporate income and expenses separately from personal finances. Maintain accounting records clearly showing profit and loss for corporate tax filing.
Set up quarterly estimated tax payments if expecting to owe $500 or more in corporate income tax annually.
How to Become an S Corporation
Converting requires meeting eligibility and filing election.
Eligibility Check
Verify requirements: domestic corporation, maximum 100 shareholders (individuals or specific trusts), U.S. citizens/residents only, one class of stock.
Filing IRS Form 2553
File Form 2553 with all shareholder signatures. Critical timing: file within two months and 15 days after the tax year start for current-year effectiveness. Calendar-year corporations must file by March 15. Missing the deadline delays the election by one year.
Late-election relief exists under Rev. Proc. 2013-30 with reasonable cause. File within three years and 75 days of the intended date, with shareholders having reported income consistently with S corp status. Write “FILED PURSUANT TO REV. PROC. 2013-30” at the top and attach a reasonable-cause statement.
State-Level S Corporation Elections
Most states recognize federal elections automatically. New York, New Jersey, Louisiana, and Arkansas require separate state filings. Check requirements for state-level pass-through treatment.
Maintaining Eligibility
Monitor compliance continuously. Adding a 101st shareholder, accepting a foreign investor, or issuing a second stock class terminates the election immediately, creating a surprise C corp conversion with tax consequences. Implement controls preventing prohibited transfers.
Compliance Requirements for S Corps and C Corps
Both carry ongoing burdens beyond tax filing. Here are the compliance requirements for S Corps and C Corps.
Corporate Governance Requirements
Hold annual shareholder meetings to elect directors. Directors meet regularly for major decisions, appointing officers. Document meetings with written minutes proving separate entity operation.
Annual Reports and State Fees
File annual reports updating the registered agent, directors, and address. States charge $50-$800 franchise taxes. Missing deadlines brings late fees, eventual administrative dissolution.
Recordkeeping Requirements
Maintain comprehensive records: Articles, bylaws, minutes, stock ledger, financial statements, and tax returns. Poor recordkeeping pierces the corporate veil, exposing shareholders to personal liability.
IRS Filing Obligations
C corps file Form 1120 annually plus quarterly estimated taxes if owing $500+. S corporation files Form 1120S and issues K-1s to shareholders by March 15 (September 15 with extension). Both file Form 941 quarterly if employing workers.
Common errors include missed K-1 deadlines, failed estimated payments, and miscalculated reasonable compensation. Penalties range from $210 per partner monthly for late K-1s to substantial accuracy-related penalties for underpayments.
Choosing Between S Corp vs C Corp: Strategic Decision Factors
The right structure depends on specific circumstances, growth plans, and the tax situation.
Current income vs. reinvestment needs: If you’re generating steady profits and distributing to owners, an S Corp saves money. If you’re reinvesting everything for growth, C-corp retained earnings face only 21% tax without dividend tax.
Investor profile: If you need venture capital or foreign investors, you must be a C corp. But if you’re funding with personal savings, bank debt, or U.S.-based angels, an S corp works best.
Personal vs. corporate tax rates: Does your personal rate significantly exceed 21%? Retaining earnings in a C-corp might save in the short term. Moderate bracket taking distributions? An S Corp pass-through likely wins.
Ownership plan: If you’re keeping it closely held with few U.S. owners, an S corp fits. But if you’re scaling to hundreds of shareholders or going public, C-Corp is mandatory. So you want to think five years ahead.
Exit and IPO strategy: If you’re selling to a larger company, C-corporations appeal to corporate acquirers. Pursuing an IPO? The S corporation’s 100-shareholder limit makes this impossible, so you’ll need a C corp. QSBS benefits also favor C-corp exits.
Foreign or institutional investment: If there’s any chance of foreign partners or institutional backing within five years, you can start as a C corp. Converting an S corp to a C corp is easy, but it loses the QSBS holding period years and creates tax complications.
When an LLC May Be Better Than Either S or C Corp
Limited Liability Companies offer a middle ground. LLCs provide corporate-style liability protection with partnership tax flexibility and minimal compliance. No annual meetings, minutes, or stock certificates required.
LLCs choose tax treatment—elect partnership, S corp, or C corp taxation while maintaining LLC structure. This flexibility lets you start simple and elect corporate taxation later without restructuring.
Consider LLCs when wanting liability protection without corporate formalities, needing flexibility to change tax treatment, or not ready for corporation compliance. Many start as LLCs, converting to C corps when raising institutional capital.
S Corp vs C Corp Examples (Applied Scenarios)
Real examples clarify which structure fits different business models and demonstrate strategic application.
S Corp Scenario: A marketing consultant generates $200,000 in annual revenue with $50,000 in business expenses, leaving $150,000 in net profit. She pays herself a $90,000 salary (in line with industry standards) and takes $60,000 in distributions.
She pays payroll tax on the salary but not the distributions, saving roughly $9,000 annually. The QBI deduction gives her an additional $12,000 write-off. She has no plans to raise outside capital. S corp status maximizes her after-tax income.
C Corp Scenario: A software startup raised a $2 million seed round from venture capitalists who demanded preferred stock with a 1X liquidation preference and anti-dilution protection provisions.
The company plans three more funding rounds before an acquisition or IPO. QSBS benefits could potentially eliminate capital gains tax on exit.
Foreign technical co-founders eventually joined as shareholders. The one-class stock rule made an S corp impossible—a C corp was the only option for this trajectory.
Frequently Asked Questions (FAQ)
Can an S corporation have foreign shareholders?
No. S corporations prohibit foreign shareholders entirely. All shareholders must be U.S. citizens or residents. Even if one nonresident alien terminates your S corporation election immediately, it will convert you to C corporation status with potential tax consequences.
Who pays more taxes: an S corp or a C corp?
It depends on your circumstances. S corporations typically save money for profitable businesses by distributing earnings because they avoid double taxation. C corps face corporate tax plus dividend tax, creating an effective rate around 36.8% on distributed profits.
However, C corps retaining earnings only pay 21% corporate tax without distribution tax. If your personal rate exceeds 21% significantly and you’re reinvesting profits, a C corp might save money.
Can you switch between S corp and C corp?
Yes, but easier in one direction. Converting an S corp to a C corp is simple—file a revocation of your S election. Converting a C corporation to an S corporation requires filing Form 2553 and meeting all eligibility requirements. Once you revoke S corp status, you generally can’t re-elect for five years without IRS consent.
Is an LLC better than an S Corp?
Neither is universally better—it depends on your needs. LLCs offer more flexibility and less compliance burden, but can face self-employment tax on all income.
S corporations save on self-employment tax through the salary-distribution split but require corporate formalities. Many small businesses start as LLCs taxed as S corporations.
How do you verify a company’s tax classification?
Request copies of recent tax returns. C corps file Form 1120; S corps file Form 1120S. You can also check state business registrations, though these show legal entity type (corporation, LLC), but not tax classification. For due diligence, ask for the original Form 2553 if they claim S corp status.
Conclusion
S corporations and C corporations serve different strategic purposes. S corporations deliver tax efficiency through single-layer taxation and lower payroll taxes, making them ideal for profitable businesses distributing earnings to a small group of U.S. owners.
C corps provide unlimited scaling potential through flexible ownership and multi-class stock, making them essential for companies raising venture capital, going public, or accepting foreign investment.
Your optimal choice depends on tax strategy first—are you distributing profits or reinvesting for growth? Investment goals second—do you need institutional capital or venture funding? And the long-term business trajectory is third—are you building a lifestyle business or positioning for acquisition or IPO?
If you’re generating steady profits with no plans for outside investment, S corporation status likely saves significant tax dollars. But if you’re pursuing aggressive growth with multiple funding rounds and global ambitions, a C-corp structure removes the constraints that would limit your success.
When evaluating corporate structures, think beyond today. Consider where you’ll be in five years, who you’ll need as investors, and what exit options you want to preserve. The structure you choose now shapes those possibilities for years to come.
