In the S-Corp vs C-Corp decision, most small businesses that pay their profits out to the owners come out ahead as an S-Corp. Most startups that plan to raise venture capital need to be a C-Corp. Both give you the same liability protection. What separates them is how they’re taxed, who’s allowed to own them, and how easily they can take on investors.
S-Corp vs C-Corp at a glance
| Feature | S-Corporation | C-Corporation |
|---|---|---|
| Taxation | Pass-through (single taxation) | Corporate + dividend (double taxation) |
| Corporate tax rate | None | 21% federal |
| Self-employment tax savings | Yes | N/A |
| Maximum shareholders | 100 | Unlimited |
| Shareholder types | U.S. citizens/residents only | Any person or entity |
| Stock classes | One class only | Multiple classes allowed |
| Ability to go public | No | Yes |
| Retained earnings | Taxed to shareholders | Can be retained without distribution |
How are they taxed differently?
A C-Corp is taxed as its own entity. It pays 21% federal income tax on its profits, and when it pays out what’s left as dividends, shareholders pay personal income tax on them (0-20% depending on bracket).
An S-Corp pays no federal income tax itself. Its profits pass through to the shareholders, who report their share on their personal returns.
Here’s $100,000 of profit both ways. The S-Corp column assumes the owner is in the 24% bracket, and the C-Corp column assumes every dollar is paid out as a dividend taxed at 20%. Real returns are messier, but the gap is the point.
| Step | C-Corp | S-Corp |
|---|---|---|
| Business profit | $100,000 | $100,000 |
| Corporate tax | -$21,000 (21%) | $0 |
| Passed to shareholder | $79,000 as dividends | $100,000 |
| Shareholder tax | -$15,800 (20% dividend rate) | -$24,000 (24% bracket) |
| Net to shareholder | $63,200 | $76,000 |
| Total tax | $36,800 (36.8% effective) | $24,000 |
In this example the S-Corp saves $12,800.
Where does the self-employment tax saving come from?
Owners who work in an S-Corp get a second break. Their salary is subject to 15.3% payroll taxes (Social Security plus Medicare), but distributions aren’t.
Say the business makes $100,000 and you pay yourself a reasonable salary of $60,000. Payroll taxes on the salary come to $9,180. The other $40,000 comes out as a distribution with no payroll tax, which saves about $6,120 compared with running the same business as a sole proprietorship or partnership.
Don’t push this too far. The salary has to be reasonable, meaning roughly what you’d pay someone else to do your job. The IRS looks at industry standards, your experience, the time you put in, and comparable wages in your area.
Who can own each one?
To keep S-Corp status, you must follow strict ownership rules:
- No more than 100 shareholders (family members can count as one)
- Only U.S. citizens or permanent residents, so no foreign owners
- Only individuals, certain trusts and estates, so no corporations or partnerships
- One class of stock, with identical rights for every share
Break any of these and the IRS can revoke your S-Corp status, which turns you into a C-Corp.
A C-Corp has no ownership restrictions. Any number of shareholders, foreign investors, other corporations, partnerships and trusts can all own stock, and you can issue common, preferred, voting and non-voting shares.
Which is better for raising money?
The C-Corp, by a wide margin. It can issue preferred stock with liquidation preferences, dividends and special rights. It can take money from VCs, corporations and foreign investors, and issue SAFEs, convertible notes and other startup-friendly securities. Only C-Corps can go public.
An S-Corp’s rules shut out foreign investors, corporate investors and preferred stock, and most venture capitalists won’t invest in one. If you plan to raise institutional investment, a C-Corp is almost always required.
When should you choose an S-Corp?
An S-Corp fits when your business makes steady profits that you plan to take home, your owners are few and all U.S. citizens or residents, and you don’t plan to raise outside investment or sell to a large buyer. Consulting firms, professional practices, established service businesses and family companies are typical. So are solo owners and spouses running a business together.
The self-employment tax saving is the main draw. If you’re paying 15.3% self-employment tax on all your profit today, potential savings run about $6,000-$15,000+ a year once profit passes $75,000.
S-Corp status also works well with SEP-IRAs and Solo 401(k)s. Some owners time their distributions around their personal tax situation, too.
When should you choose a C-Corp?
Choose a C-Corp if you plan to raise venture capital (VCs almost universally require it) or go public. You’ll also need one if your investors include foreign nationals, foreign entities or other corporations.
The C-Corp is also the better home for a business that needs to keep its profits. S-Corp shareholders owe tax on their share of profit whether it’s distributed or not. A C-Corp can retain earnings for growth without any immediate tax to shareholders, which suits capital-intensive businesses that reinvest heavily.
It’s also better for generous employee benefits. Health insurance premiums (100% deductible and not taxable to employees), group term life insurance, educational assistance and dependent care assistance are either unavailable or limited for S-Corp owners.
C-Corp owners have ways to shrink double taxation: pay themselves reasonable salaries (deductible to the corporation, unlike dividends), retain earnings instead of distributing them, offer deductible fringe benefits, and, for qualifying businesses, use the Qualified Small Business Stock (QSBS) exclusion, which can exclude up to $10 million in capital gains on stock held 5+ years.
What would we pick in common situations?
| Situation | Our pick | Why |
|---|---|---|
| Solo management consultant earning $150,000 a year, no plans for investors | S-Corp | Saves $10,000+ a year in self-employment taxes, and ownership is simple |
| SaaS startup planning a seed round next year | C-Corp | VCs require it, you’ll need preferred stock, and you may have foreign or corporate investors |
| Restaurant owned 50/50 with your spouse | S-Corp | Pass-through taxation lowers overall taxes, and there are no plans for outside money |
| Biotech company that will reinvest in R&D for years before it profits | C-Corp | Retains earnings without shareholder tax, needs outside investment, may pursue an IPO |
If you can’t decide between them, ask yourself whether you’ll take outside investment in the next few years. If not, the S-Corp is usually the answer.
Can you switch later?
Yes, in either direction, but there are traps.
To go from C-Corp to S-Corp, file IRS Form 2553 by March 15 for a current-year election, and meet all the S-Corp eligibility rules. Watch for the built-in gains tax. If you convert a profitable C-Corp, you may owe tax on appreciation from the C-Corp years.
To go from S-Corp to C-Corp, you revoke the election, which requires majority shareholder consent. (Breaking an S-Corp rule also does it, but that’s not a plan.) The change takes effect January 1 of the following year unless you choose a specific date. Once you revoke, you generally can’t re-elect S-Corp status for 5 years without IRS permission.
State taxes add another layer. Some states don’t recognize S-Corp status, income tax rates vary a lot, and franchise taxes may apply whichever structure you pick.
Frequently asked questions
Can an LLC be an S-Corp or a C-Corp?
An LLC can elect to be taxed as an S-Corp (Form 2553) or a C-Corp (Form 8832). It remains an LLC legally but is taxed like a corporation.
Which saves more on taxes?
For most small businesses that distribute profits to their owners, the S-Corp, because of pass-through taxation and the self-employment tax savings. For businesses that retain earnings or have complex investor needs, a C-Corp may be more efficient.
Is an S-Corp worth it at low profit levels?
An S-Corp is usually worth considering once the business earns $50,000+ in annual profit. Below that, ask a tax professional whether the savings cover the cost of running payroll for yourself.
Before you elect
Sketch out your next five years: who might invest, whether you’ll keep profits in the business, and roughly what you’ll pay yourself. Then run both versions of the $100,000 example with your own numbers and take them to a tax professional. If no outside investor shows up anywhere in that five-year sketch, file your formation documents and Form 2553 and enjoy the lower tax bill.