The main difference between an S Corp and a C Corp is how the IRS taxes the business. With C Corp taxation, the business pays corporate income tax, and owners pay tax again on dividends. With S Corp status, by contrast, profit passes through to the owners, who pay tax once on their personal returns.
In general, S Corp status fits small businesses and Business-of-One owners whose owners are all based in the U.S. C Corp taxation, on the other hand, tends to fit companies that plan to raise outside investment, issue more than one class of stock or eventually go public. This guide explains both, starting with a common source of confusion: the difference between a corporation as a legal entity and C Corp taxation.
What is the difference between S Corp and C Corp?
Both “S Corp” and “C Corp” describe how the IRS taxes a business. Neither one describes the business’s legal framework. That’s why it helps to separate two layers: the legal setup you choose with your state, and the tax setup the IRS applies to it.
Legal setup vs. tax setup: clearing up the terms
Your legal setup is the entity you form with your state. For most small businesses, that’s either an LLC, formed by filing articles of organization, or a corporation, formed by filing articles of incorporation. Your tax setup, meanwhile, is how the IRS taxes that entity. Each entity starts with a default tax setup, and you can elect a different one.
| Legal entity (formed with your state) | Formation document | Default tax setup | Tax setups it can elect |
|---|---|---|---|
| Single-member LLC | Articles of organization | Taxed like a sole proprietorship | S Corp status or C Corp taxation |
| Multi-member LLC | Articles of organization | Taxed like a partnership | S Corp status or C Corp taxation |
| Corporation (stock corporation) | Articles of incorporation | C Corp taxation | S Corp status |
In other words, “corporation” on its own refers to the legal entity. “C Corp taxation” refers to the default tax treatment that applies to a corporation unless it elects S Corp status. “S Corp status,” meanwhile, is a tax election that an eligible corporation or an eligible LLC can make. As a result, an S Corp isn’t a separate type of entity, and a corporation doesn’t have to stay under C Corp taxation. Throughout this guide, “corporation” means the legal entity, while “S Corp status” and “C Corp taxation” mean the tax setup.
Who generally chooses S Corp status vs. C Corp taxation
| S Corp status is common for | C Corp taxation is common for |
|---|---|
| Business-of-One owners and small businesses | Companies planning an IPO or to go public |
| Businesses whose owners are all U.S. citizens or residents | Businesses with international owners or investors |
| Businesses with 100 or fewer shareholders | Businesses that expect more than 100 shareholders |
| Businesses with one class of stock | Businesses that need more than one class of stock, such as preferred stock for investors |
| Owners who want profit to pass through and be taxed once | Startups raising venture capital or angel investment |
| Owners who take most of the profit out of the business | Businesses owned partly by other companies, or that plan to reinvest most profits |
Legal setup: stock corporation vs. LLC
Before you choose a tax setup, you choose a legal entity. Both LLCs and corporations protect your personal assets from business debts and claims. However, they work differently day to day.
- Corporation: Shareholders own a corporation through stock. A board of directors oversees it, and it typically follows bylaws, holds annual meetings and keeps formal records.
- LLC: Members own an LLC, and an operating agreement sets out how it runs. As a result, it usually comes with fewer formalities than a corporation.
For a Business-of-One, an LLC is the more common choice. It’s simpler to run, and it can still elect S Corp status or C Corp taxation later. In fact, a common setup is a single-member LLC taxed as an S Corp. For a deeper comparison of the two entities, see LLC vs. corporation. You can also learn more about choosing a business entity.
Tax setup: S Corp status vs. C Corp taxation
Once you have a legal entity, the next question is how the IRS taxes it. Here’s how each tax setup works.
How S Corp status works
S Corp status is a federal tax election that makes the business a “pass-through entity.” The IRS lets the business pass its income and losses through to its shareholders for tax purposes (IRS). As a result, the business generally doesn’t pay federal income tax itself.
If you work in the business, you pay yourself a “reasonable compensation” salary through payroll. Your business pays 7.65% in payroll taxes on that salary, and it withholds another 7.65% from your pay for Social Security and Medicare. You then pay income tax on your salary and on your share of the profit. However, the profit you take as distributions avoids payroll taxes, which is where the potential savings come from. For the full picture, see our S Corp taxes guide.
To qualify, the business can have no more than 100 shareholders and only one class of stock. Shareholders generally must be individuals who are U.S. citizens or residents, though certain trusts and estates also qualify. Partnerships, corporations and nonresident aliens can’t be shareholders. For a full introduction, see what an S Corp is.
How C Corp taxation works
C Corp taxation is the default for a corporation. It also applies to an LLC that elects corporate taxation without electing S Corp status.
Under C Corp taxation, profits face two layers of tax. First, the business pays corporate income tax, a flat 21% under current law. Then shareholders pay income tax on any salary they receive, plus any dividends the business pays from its profits.
That may sound heavy. However, C Corp taxation offers flexibility that S Corp status doesn’t. There’s no limit on the number of shareholders, shareholders can live anywhere, and the business can issue more than one class of stock. In addition, the business pays only the corporate rate on profits it keeps and reinvests, until it pays them out.
S Corp vs. C Corp: pros & cons
Both tax setups come with trade-offs, depending on the type of company you run.
S Corp status
| Pros | Cons |
|---|---|
| No federal corporate income tax on business profit | You file a business tax return in addition to your personal return |
| Potential savings on self-employment tax compared with a sole proprietorship | You need payroll, more detailed bookkeeping and a reasonable salary |
| Possible eligibility for the QBI deduction, permanent under current law | Limited to 100 shareholders and one class of stock |
| Business losses can generally pass through and reduce your taxable income, subject to limits | Your state may tax the business differently, since S Corp status is a federal election |
| No new entity to form; you elect it for an existing LLC or corporation | The IRS pays close attention to reasonable salary, so a tax professional can help you stay compliant |
C Corp taxation
| Pros | Cons |
|---|---|
| Unlimited shareholders | Double taxation on profits paid out as dividends |
| Shareholders don’t have to be U.S. citizens or residents | Usually requires forming a corporation, a more complex and costly entity |
| More than one class of stock, such as preferred stock for investors | More formalities, such as a board, bylaws and annual meetings |
| Often preferred by venture capital investors, and the standard setup for an IPO | Business losses stay with the business instead of passing through to your personal return |
| A flat corporate rate on profits kept in the business |
Is it better to be an S Corp or C Corp?
For most Business-of-One owners and small businesses, an LLC with S Corp status is the better fit. Many freelancers and independent contractors move from a sole proprietorship to an LLC, and then to S Corp status, for liability protection and potential tax savings.
On the other hand, C Corp taxation makes more sense if your plans include outside investors, more than one class of stock, international owners or going public. Consult a lawyer and an accountant to decide what fits your situation.
Other considerations: administrative requirements and state impact
Taxes aren’t the only difference. The ongoing work and your state’s rules can also shape which setup fits your business.
Administrative requirements
A common misconception is that S Corp status requires a board of directors, bylaws and corporate minutes. In fact, those formalities come from the legal entity, not the tax status. A corporation, the usual setup for C Corp taxation, generally needs a board, bylaws, annual shareholder and director meetings, and written minutes. If a corporation elects S Corp status, it still follows those formalities, because it’s still a corporation legally. An LLC with S Corp status, by contrast, doesn’t take them on.
That said, S Corp status brings its own administrative work: payroll for your reasonable salary, more detailed bookkeeping and an annual S Corp business tax return. C Corp taxation adds a corporate tax return, on top of the corporate formalities. For a Business-of-One, that corporate overhead is usually more than the business needs.
State impact
States add another layer. Some charge corporate income or franchise taxes, and most charge annual report fees for both corporations and LLCs. In addition, states vary in how they treat S Corp status. Some follow the federal election automatically, some require a separate state election, and a few don’t recognize it or tax S Corps at the entity level. Before you choose, check your state’s rules with your state tax agency or a local tax professional.
How to become an S Corp or a C Corp
Your tax setup starts with your legal setup. If you don’t form a legal entity, the IRS treats you as a sole proprietor. Once you form an LLC or a corporation, however, you have options for how the IRS taxes it.
Getting S Corp status
- Form your legal entity. For most small businesses, that’s an LLC, formed by filing articles of organization with your state. A corporation can also elect S Corp status.
- File Form 2553 with the IRS within the deadline window. Our S Corp election deadline guide covers timing, and you can find the form on the IRS website.
After the election, S Corp status comes with ongoing requirements. These include payroll for your reasonable salary, more detailed bookkeeping, an annual S Corp business tax return and any state filings. In addition, you’ll keep your entity current with your state each year.
Getting C Corp taxation
When you form a corporation by filing articles of incorporation with your state, C Corp taxation applies automatically. An LLC, meanwhile, can elect corporate taxation with the IRS, though that’s less common.
If your business has S Corp status, you could also revoke the election and move to C Corp taxation. The IRS has pointed out some tax advantages of converting, including the flat corporate rate. There’s no dedicated form for this switch. Instead, you file a revocation statement with the IRS, with consent from shareholders who hold more than half of the shares.
FAQs about S Corp vs. C Corp
Business and tax structures can be confusing, especially when you’re getting started. Here are answers to some common questions.
Why would you choose an S Corporation?
A Business-of-One taxed as a sole proprietorship pays self-employment tax on nearly all of its profit. Electing S Corp status for an LLC can reduce that tax, as long as the potential savings outweigh the cost of the extra work. Here’s a closer look at whether an S Corp is worth it.
Should a Business-of-One be a C Corp?
Usually not. For a single-owner business, C Corp taxation often adds a second layer of tax on the profit you pay yourself, plus corporate formalities like a board and meeting minutes. As a result, it’s usually more structure than a Business-of-One needs. Instead, C Corp taxation tends to make sense when you plan to raise outside investment, issue different classes of stock or go public.
Is my LLC an S Corp or a C Corp?
Neither, by default. Your LLC is a legal entity, and its default tax setup depends on how many members it has. However, you can elect S Corp status or C Corp taxation for it. For an LLC, S Corp status is the more common choice.
Which is better for taxes, LLC or S Corp?
It’s not either-or. An LLC is a legal entity that protects your personal assets, while S Corp is a tax status. As a Business-of-One, you could form an LLC and elect S Corp status, so you’d be both. For more, see LLC vs. S Corp.
What is a reasonable S Corp salary?
Reasonable pay is generally what similar businesses would pay for the same or similar services. The IRS doesn’t offer a formula, but it does provide guidance on reasonable compensation. In short, you can’t set your salary artificially low to save on taxes.
Do S Corp owners have to take a salary?
Generally, yes. If you work in the business, you must take a reasonable salary before taking distributions. In other words, if you wouldn’t work for free for another company, you can’t work salary-free for your own.
The 21% corporate rate is lower than my personal rate. Is a C Corp better?
Not necessarily. The 21% rate applies to the business’s profit, not to the money you take home. When the business pays you dividends, you pay tax on that money again. As a result, the combined tax on profit you take out can be higher than with S Corp status. In addition, you pay tax at your personal rate on any salary you take, plus payroll taxes. In short, the lower rate mainly helps when the business keeps and reinvests most of its profit.
TL;DR: Key S Corp vs. C Corp differences
The main difference between an S Corp and a C Corp is how the IRS taxes the business, not its legal framework. With C Corp taxation, profits face tax twice: at the corporate level and again at the shareholder level. With S Corp status, by contrast, owners pay income tax once on their combined salary and share of profit, plus payroll taxes on their salary.
Your legal setup also determines your starting point. A corporation starts with C Corp taxation, while an LLC starts with sole proprietorship or partnership treatment. Either one can elect S Corp status if it’s eligible. In general, S Corp status fits most small businesses, while C Corp taxation fits companies planning for investors, multiple classes of stock or an IPO.
Form your S Corp with Collective
Generally, businesses of all types can elect S Corp status, as long as they meet the eligibility rules. Collective is built specifically for single-owner businesses, from LLC formation and the S Corp election to payroll, bookkeeping and tax filings. Learn more about Collective.
This content is for educational purposes only and does not constitute legal, financial, or tax advice.
