C-Corp vs S-Corp
Compare a C corporation and an S corporation on double taxation, ownership limits, stock classes, and fit for investors, and learn when each election makes sense.
C corporation and S corporation are two different tax treatments of what is legally the same kind of entity, a corporation. The choice affects how profit is taxed, who can own shares, and how attractive the company is to investors.
At a glance
| C corporation | S corporation | |
|---|---|---|
| Entity-level federal tax | Yes, at the corporate rate | Generally none, income passes through |
| Tax on distributions | Shareholders taxed on dividends (double taxation) | Profit taxed to owners once, at personal rates |
| Shareholder limits | None | Up to 100 |
| Who can own shares | Anyone, including entities and foreign owners | US individuals and certain trusts and estates |
| Classes of stock | Multiple, including preferred | One class |
| Best for | Venture-backed and growth companies | Closely held, profitable small businesses |
Taxation
A C corporation pays a flat 21 percent federal tax on its profit, and shareholders pay tax again on dividends. An S corporation passes income, losses, deductions, and credits to shareholders in proportion to ownership, who report them on personal returns. The S structure avoids the second layer of tax. Owner-employees still must be paid reasonable wages that bear payroll tax.
Ownership and investors
S corporations are restricted to 100 shareholders, one class of stock, and eligible individual shareholders, which rules out most institutional investors. C corporations have no such limits, so they can issue preferred stock to venture funds and grant various equity awards. That is why venture-backed startups almost always use a C corporation.
Switching
A corporation can elect S status by filing Form 2553 within the allowed window, and can later revoke it. Moving from S back to C, or vice versa, can have tax consequences, including limits on re-electing. Plan the structure around your funding and exit plans rather than only the current year's tax bill.
Which to choose
- S corporation: profitable, owner-operated business with a few US owners and no plans for outside equity investment.
- C corporation: you plan to raise venture capital, offer stock options broadly, or sell to an acquirer that prefers a C corporation.
Get advice from a CPA and attorney before you choose, since the right answer depends on your income, ownership, and goals. See also LLC vs corporation.
Example: why the labels matter to investors
A startup with two founders and a friends-and-family round holds S corporation status. When a venture fund offers to invest, it will typically require preferred stock, which an S corporation cannot issue because it may have only one class of stock, and the fund itself is not an eligible shareholder. The company must revoke its S election, becoming a C corporation, before closing. The lesson is to choose the tax status that matches where the company is going, not just where it is today.
Checklist before electing S status
- All shareholders are eligible US individuals or qualifying trusts
- You have one class of stock and no plan to issue preferred shares soon
- You are ready to run payroll and pay owner-employees reasonable salaries
- Your CPA has modeled the tax saving against the added compliance cost
Disclaimer: Legal information, not legal advice. For advice about your specific situation, consult a licensed attorney or CPA in your state.