One of the most common confusions in business formation is the difference between a C-Corp and an S-Corp. Founders read about them, choose one, and lock in tax consequences they do not fully understand.
The first thing to understand: C-Corp and S-Corp are not different entity types. They are different tax elections that the same legal entity (a corporation, or in some cases an LLC) can make. A "C-Corp" is a corporation that has not elected S-Corp status. An "S-Corp" is a corporation (or LLC) that has elected S-Corp tax treatment by filing Form 2553.
This guide compares C-Corp and S-Corp tax for the cases founders actually face: solo founders, small operating businesses, and venture-backed startups.
Default tax treatment of a corporation
A corporation, by default, is a C-Corp for federal tax purposes. The corporation files its own tax return (Form 1120), pays its own federal income tax at the corporate rate (currently 21%), and distributes after-tax profits to shareholders as dividends. Shareholders pay dividend tax on what they receive.
This is the "double taxation" of C-Corps: the corporation pays tax on profits; shareholders pay tax again on the distributions.
S-Corp election
An eligible corporation (or LLC) can elect to be taxed as an S-Corp by filing Form 2553. S-Corps are pass-through entities for federal tax purposes: the corporation itself does not pay federal income tax. Profits and losses flow through to shareholders, who report their share on their personal tax returns.
This avoids double taxation. The corporation does not pay; the shareholders pay once.
S-Corp eligibility
Not every entity can elect S-Corp. Requirements:
- Be a US-formed corporation or eligible LLC.
- Have 100 or fewer shareholders.
- All shareholders must be US individuals (citizens or resident aliens), certain trusts, or certain estates. No partnerships, no corporations, no non-resident aliens.
- Only one class of stock. (Voting and non-voting shares are allowed; preferred stock is not.)
- Not be a specific ineligible type (certain banks, insurance companies, possessions corporations).
The "no non-resident aliens" rule blocks international founders from S-Corp election. The "one class of stock" rule blocks VC-backed startups (which always have preferred stock for investors).
The math: solo founder making $200,000
A solo founder runs a consulting business through an LLC or single-shareholder corporation. Net profit (after expenses, before owner pay) is $200,000.
As a default LLC (disregarded entity, taxed as sole proprietor)
- $200,000 of net profit flows to Schedule C.
- Self-employment tax (15.3%) on the full $200,000: $30,600 (with the wage base limit on Social Security portion, it is slightly less: about $26,200).
- Federal income tax: depends on filing status, but figure roughly $35,000 to $45,000.
- Total federal tax: roughly $61,000 to $71,000.
As an S-Corp (LLC with S-Corp election)
The founder pays themselves a "reasonable salary" through payroll, and takes the rest as a distribution.
- Reasonable salary: say, $80,000 (must be defensible based on industry and role). This is subject to payroll tax (both halves of FICA, 15.3%): about $12,240.
- Federal income tax on the $80,000 salary: in the founder's tax bracket.
- Remaining $120,000 is distributed to the founder. Not subject to self-employment tax. Subject to federal income tax at the founder's bracket.
- Total federal tax: roughly $48,000 to $55,000.
Savings: approximately $13,000 to $16,000 per year in self-employment tax avoided on the distribution portion.
The savings depend on the spread between total profit and reasonable salary. Larger spread, larger savings. Reasonable salary is determined by industry, role, and what a comparable position pays. The IRS challenges suspiciously low salaries.
As a C-Corp
- $200,000 of corporate profit, taxed at the 21% federal corporate rate: $42,000.
- $158,000 remaining. Pay as salary to the founder (then it is taxed as wages), or distribute as dividends.
- If paid as salary: subject to payroll tax (employee and employer halves), then federal income tax.
- If distributed as qualified dividends: taxed at 15% to 20% capital gains rate (no payroll tax).
- Effective total federal tax: typically higher than S-Corp for this profile.
C-Corp is rarely the optimal choice for a solo operating business at this size. The double taxation eats more than the S-Corp's payroll requirements.
When C-Corp wins anyway
Despite the math above, C-Corp is the default for venture-backed startups. Why:
Investor requirements
Most VCs cannot invest in S-Corps for several reasons:
- S-Corp can only have 100 shareholders. VC funds have hundreds of partners.
- S-Corp requires shareholders to be US individuals. VC fund partners include partnerships and corporations.
- S-Corp can have only one class of stock. VC investors take preferred stock with rights different from common.
If you raise institutional capital, you need to be a C-Corp before the round closes (or you become one as part of the round, which is more expensive than starting that way).
QSBS
Qualified Small Business Stock under IRC Section 1202 lets founders exclude up to $10 million (or 10x basis) of capital gains on the sale of qualifying C-Corp stock held more than 5 years. S-Corp stock does not qualify.
For founders building a company they plan to sell, QSBS can save millions in capital gains tax. This alone justifies C-Corp structure for many startups.
Employee equity
C-Corps can issue ISOs (Incentive Stock Options) with favorable tax treatment for employees. S-Corps can only issue NSOs. For startups granting equity to employees, ISOs are the preferred structure.
Pass-through vs accumulation
Another important difference: S-Corp profits pass through to shareholders whether they receive them or not. If the S-Corp earns $500,000 and reinvests all of it in growth (no distributions), the shareholders still owe tax on $500,000 of pass-through income.
This is why S-Corps typically distribute enough cash to cover their owners' tax bills, even when the business wants to retain capital. This "tax distribution" provision is standard in S-Corp operating agreements.
C-Corps can retain earnings without immediate shareholder tax. The corporation pays its own tax; shareholders pay only on dividends or eventual sale.
State considerations
Some states do not recognize federal S-Corp election. California, for example, taxes S-Corps at 1.5% of net income (the "Californian S-Corp tax"). New Hampshire and Tennessee historically taxed S-Corps as if they were C-Corps. Texas does not have personal income tax, so the pass-through to individuals does not save state tax there.
State tax considerations can swing the C-Corp vs S-Corp decision, especially for founders in high-tax states.
How to elect
S-Corp election is made by filing Form 2553 with the IRS. Deadlines:
- For new entities: within 2 months and 15 days of formation.
- For existing entities: by March 15 of the year you want the election to take effect.
We file Form 2553 for $99 (free with Growth plan). The election once made remains in effect until revoked.
Revocation
An S-Corp can revoke its S-Corp election at any time. Once revoked, a 5-year waiting period applies before re-electing.
The takeaway
If you are running a solo or small operating business and net profit is or will be above $60,000 to $80,000, S-Corp election typically saves meaningful self-employment tax. We file Form 2553 for you.
If you are building a venture-backed startup or planning to issue stock to many employees, C-Corp is the standard structure. The double taxation is offset by QSBS, by clean investor terms, and by the option pool mechanics that C-Corps support cleanly.
If you are uncertain which category you fit, talk to a partner CPA before filing the election. The cost of getting an opinion is small; the cost of unwinding the wrong election can be significant.