S Corp vs. C Corp: What’s the Difference?

When it comes to structuring a business, choosing between an S Corporation and a C Corporation can significantly impact your company’s financial and operational dynamics. Both S Corps and C Corps offer distinct advantages and limitations, making it crucial for business owners to understand their differences before making a decision. At the core, the distinction lies in how each entity is taxed and the implications for shareholders.

A financial advisor can help you compare how an S Corp or C Corp would affect your personal taxes and retirement plans.

An Overview of How Businesses Are Taxed

Starting a business is a big decision. But it’s just one of many to follow. Most importantly, you’ll decide which type of entity your business should be. Among several choices including sole proprietorship, partnership and limited liability company (LLC), a corporation is one of the most popular choices.

Corporations offer some key advantages over other business entities. For starters, unlike partnerships and sole proprietorships, the owners aren’t personally liable for the business’s debts. A corporation is also usually the best choice if you plan to grow a company to a considerable size.

However, choosing to incorporate isn’t the end of it. Entrepreneurs also need to choose what kind of corporation to become. The choices – C Corp and S Corp – get their names from the relevant section of the Internal Revenue Code that governs how they are taxed. But there is more than a single letter’s difference between them.

S Corp vs. C Corp: Similarities and Differences

When deciding on a business structure, understanding the differences between an S Corporation (S Corp) and a C Corporation (C Corp) is crucial. Both are types of corporations that offer limited liability protection, meaning that the personal assets of shareholders are generally protected from business debts and liabilities. However, they differ significantly in terms of taxation, ownership and operational requirements.

Both types of corporations are incorporated the same. State laws govern incorporation and state business organization laws treat all corporations the same. Both offer the important advantage of limited liability.

C Corps and S Corps have similar requirements for adopting bylaws, issuing shares of stock, holding meetings of shareholders and directors, filing annual reports and paying fees. They are organized similarly, with boards of directors, directors, officers and shareholder owners.

The first major difference is that you don’t have to do anything to be a C Corp. That is the default tax status the IRS assigns to corporations. You can, however, choose an S Corp tax structure. To do this, file IRS Form 2553 after incorporating.

S Corp vs. C Corp: Taxes

The next major difference concerns taxes. C Corps are subject to double taxation. The corporation pays federal income taxes on net income. The shareholders pay federal income taxes again on any dividends they receive.

S Corps, on the other hand, are pass-through entities. The S Corp doesn’t pay taxes. Instead, any profits flow untaxed to the owners, who pay income taxes at their rates. If the S Corp has losses, those flow through to owners as well. The owners can then use those losses on their returns to shelter income from other sources. C Corps can’t pass on losses to owners.

While C Corp profits are taxed twice, since the 2017 Tax Cuts and Jobs Act was signed into law, C Corp taxes are a flat 21%. Individual federal income tax rates can go as high as 37%.

Another thing that changed with the 2017 tax law is that owners of pass-through entities like S Corps may be able to deduct 20% of the business income from their tax returns. C Corp owners can’t do that.

S Corp vs. C Corp: Ownership Differences

The third big difference is ownership. C Corps have no general federal tax-law limits on the number or types of shareholders. They can have as many owners as they like, and individuals, corporations and other entities can generally own shares.

S Corps can only have 100 shareholders. And owners have to be eligible shareholders, generally U.S. citizens or resident individuals, certain trusts and estates, and certain qualifying tax-exempt organizations. Nonresident aliens generally cannot be shareholders. Certain family members may be treated as one shareholder when applying the 100-shareholder limit.

C Corps can also issue multiple classes of stock, such as common and preferred shares. S Corps can only have one class for federal tax purposes, although differences in voting rights are permitted if the shares have identical distribution and liquidation rights.

When a C Corp Might Make Sense

A C Corp may be the best choice for a business that seeks investment from venture or angel investors. It also may work for businesses that plan to grow large enough to someday have an IPO or acquisition occur. This is because of the lack of restrictions on ownership and share classes.

A C Corp may also make sense if the business reinvests most or all profits rather than distributing them as dividends. That can defer shareholder-level dividend taxation, although corporate income remains subject to tax and later distributions or stock sales can create additional tax liabilities.

C Corps can also look good for businesses that have lots of fringe benefits or plan large charitable contributions. C Corps can claim benefits and donations as deductions but S Corps face different rules and limitations. For example, certain fringe benefits provided to S Corp shareholders who own more than 2% of the business are treated differently for tax purposes, while charitable contributions generally pass through to shareholders and are subject to applicable deduction limits.

When an S Corp Might Make Sense

An S Corp can be a tax-efficient option for many small business owners because it avoids the general corporate-level income tax and subsequent shareholder-level tax on dividends. For a small business that can get the qualified business income deduction, an S Corp could be even more attractive.

Early-stage businesses that anticipate losses might also benefit from an S Corp, since those losses can pass through to owners as tax deductions, subject to applicable loss limitations. Owners who work in the business and draw a salary might choose an S Corp because it can help minimize self-employment taxes, as S Corp distributions generally are not subject to self-employment tax. However, shareholder-employees must receive reasonable compensation for services performed, and those wages are subject to applicable payroll taxes.

How S Corp and C Corp Taxes Compare on $100,000 in Profit

The tax differences between S Corps and C Corps become clearer when comparing how each structure treats the same amount of business profit. The result depends on whether the business distributes its earnings, the shareholder’s individual tax rate and other applicable deductions and taxes.

Suppose a corporation earns $100,000 in taxable profit before corporate income taxes. For this comparison, assume the amount represents profit after deductible operating expenses, including any required shareholder compensation. The company has one shareholder, and state taxes, additional federal taxes and shareholder deductions are excluded.

For a C Corp, the federal corporate income tax rate is 21% in 2027. ¹ If the corporation distributes all remaining profits as qualified dividends to a shareholder subject to the 15% federal qualified dividend tax rate, the calculation would look like this:

For an S Corp, assume the shareholder is paid a reasonable salary through payroll, which the business deducts as an expense, and $100,000 in profit remains after that salary. These profits pass through to the shareholder’s individual tax return, Form 1040, through a Schedule K-1. The salary itself is taxed separately as W-2 income and isn’t included in this calculation. If the shareholder’s entire share of the remaining profit is taxed at an assumed 24% federal marginal income tax rate, the resulting tax would be $24,000 before any applicable QBI deduction.

If the full $100,000 qualifies for the 20% QBI deduction and the shareholder can claim the entire deduction, the calculation changes:

These simplified calculations assume the shareholder has sufficient other taxable income for the stated marginal rate to apply to the entire amount and, in the S Corp example, qualifies for the full QBI deduction. They do not represent the shareholder’s effective tax rate on total income. The S Corp calculation also assumes sufficient stock basis for a tax-free distribution of the earnings and no entity-level tax.

Under these assumptions, the remaining $100,000 of S Corp business profit produces $13,650 more after-tax income than the $100,000 of C Corp profit in this example. However, that difference is not a guaranteed tax saving. The comparison excludes the S Corp shareholder’s salary and related payroll taxes. A different individual tax bracket, ineligible QBI, payroll costs or state taxes could substantially change the outcome.

A C Corp that retains its $79,000 in after-tax profit instead of distributing dividends would not trigger the shareholder-level dividend tax in this example. That may make the C Corp structure more attractive for a business planning to reinvest earnings, although future distributions or stock sales could create additional taxes.

A tax professional can compare the expected tax liability under both structures using your company’s projected profits, compensation expenses and distribution plans.

Bottom Line

Choosing between an S Corp and a C Corp is a key decision for business owners deciding on the best structure for their company. Both types of corporations offer limited liability protection, but they differ significantly in terms of taxation and ownership. An S Corp allows profits and losses to pass through to shareholders’ tax returns, avoiding the general double taxation associated with C Corps. However, it has restrictions on the number and type of shareholders, which can limit growth potential.

“From my experience, most business owners that I’ve worked with utilize S-Corps over C-Corps, because their businesses are relatively small. In either instance, I’d highly recommend working with a tax professional because proper accounting and managing of taxes become much more difficult than a sole proprietorship or LLC,” said Matthew Hofacre, MSPFP, CFP®, EA.

Matthew Hofacre, MSPFP, CFP®, EA provided the quote used in this article. Please note that Matthew is not a participant in SmartAsset AMP, is not an employee of SmartAsset and has been compensated. The opinion voiced in the quote is for general information only and is not intended to provide specific advice or recommendations.

Business Tax Tips

• If parsing S Corp vs C Corp tax advantages for your business still has you puzzled, consider talking to a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• S Corp vs C Corp tax advantages have significant differences when taxed. If you’re a small business owner trying to figure out your business’ tax situation, SmartAsset’s small business tax guide can explain the basics.

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