What is the difference between an S-Corp and a C-Corp?

There is no such thing as forming an S corporation at the state level. You form a corporation, and it is a C corporation by default.

Filing an election converts its tax treatment to Subchapter S. Nothing about the legal entity changes in the process.

What changes is who pays the tax and how many times. Everything else follows from that.

A C corporation is a separate taxpayer. It computes its own income and pays a flat twenty one percent federal rate. There are no graduated brackets and no pass through to owners. The entity files Form 1120 each year.

The second layer arrives when profit leaves the company. Dividends are taxed again on the shareholder's return. Qualified dividends face preferential capital gain rates plus the net investment income surtax. The combined burden on distributed profit is meaningfully higher than the entity rate alone.

Owners can reduce the first layer through deductible salary. That converts corporate profit into wages taxed once. The IRS scrutinizes compensation in the opposite direction here, questioning whether it is excessive. Excessive salary gets recharacterized as a disguised dividend.

Two penalty taxes police profits that never leave. The accumulated earnings tax reaches income held beyond the reasonable needs of the business. A separate tax targets closely held companies with mostly passive income. Both apply at twenty percent above their thresholds.

An S corporation generally pays no federal income tax. Profit, loss, deductions, and credits flow to shareholders on Schedule K-1. Each owner reports the allocated share on a personal return. The entity files Form 1120-S as an information return.

Allocations must follow ownership percentages exactly. There are no special allocations as in a partnership. Distributions above a shareholder's basis become taxable gain. Losses are limited by basis and at risk rules.

Owner employees must receive reasonable compensation on a W-2. Only those wages carry Social Security and Medicare tax. Distributions above the salary carry none, which is the primary attraction. Eligibility rules are set out here on the agency's own page.

Two entity level taxes still apply in narrow cases. A former C corporation faces the built in gains tax during a five year recognition period. A company with substantial passive income and old earnings faces a separate charge. Neither affects a business that was always an S corporation.

The table below isolates the differences that drive real decisions. The stock exclusion row is the one owners most often miss. It has grown considerably more valuable in recent years. Read the ownership rows carefully if outside capital is in your future.

The stock exclusion deserves elaboration because the rules changed materially. Qualifying shares issued after early July 2025 now reach a fifteen million dollar per issuer cap. The corporate gross asset ceiling rose to seventy five million. Exclusions now tier at three, four, and five year holds.

Only a domestic C corporation can issue that stock. An S corporation cannot, and neither can an LLC taxed as a partnership. The revised rules are walked through there in professional commentary. One caution applies: gain not excluded under a shorter hold is taxed at twenty eight percent.

Neither structure is better in the abstract. The right answer depends on whether profit leaves the company and who owns it. The factors below capture the decision in practice. Any one of them can control the outcome.

• Choose a C corporation when profits are reinvested rather than distributed
• Choose a C corporation when venture investors, entities, or foreign owners participate
• Choose a C corporation when the stock exclusion is central to your exit plan
• Choose a C corporation when owner health and fringe benefits are a major cost
• Choose an S corporation when owner operators take profit out every year
• Choose an S corporation when the qualified business income deduction is available
• Choose an S corporation when losses should offset other shareholder income

The reinvestment point is the cleanest dividing line. A company retaining earnings pays one layer of tax at a low rate. A company distributing earnings pays two layers on the same dollars. Growth stage businesses often favor the first pattern.

Conversion is possible in both directions but not symmetric. Electing S status after operating as a C corporation triggers the recognition period. Revoking S status generally imposes a five year wait before re-electing. Planning changes are reviewed by advisors in current firm guidance.

A profitable service business with owner operators usually wants S status. The owners take profit annually, so the second layer would be unavoidable otherwise. The deduction for qualified business income adds further value. Payroll tax savings on distributions complete the case.

A capital intensive or venture backed company usually wants C status. Institutional investors are frequently ineligible S shareholders anyway. Preferred stock is a second class and would terminate the election. Retained earnings compound at the lower entity rate.

The exit plan can override both analyses. A founder building toward a sale within a decade should model the stock exclusion carefully. That benefit is unavailable to any pass through entity. For some businesses it exceeds every annual savings the S election could produce.

A C corporation pays its own tax and its shareholders pay again on dividends. An S corporation pays no federal entity tax and reports profit to shareholders instead. That is the entire structural difference, and everything else derives from it. Both remain the same corporation under state law.

Distribute profit annually and the S election usually wins. Retain and reinvest profit and the C corporation often does. Outside investors, foreign owners, and multiple stock classes force the C corporation regardless. And if a sale is the goal, model the stock exclusion before electing anything.