Topic 09 · 6 min read
Deciding Between an S Corporation and a C Corporation
One layer of tax or two — and what you get for the second.
Both are corporations under state law; the difference is how they are taxed. An S corporation passes profit to the owners' personal returns. A C corporation pays its own tax, and owners pay again when profit is distributed.
What to know
- One layer versus two
- S corporation profit is taxed once to the shareholders. C corporation profit is taxed at the corporate rate, then again as dividends when paid out.
- Reasonable salary
- An S corporation owner who works in the business must take a reasonable W-2 salary; remaining profit escapes self-employment tax, which is the main draw.
- Ownership limits
- S corporations cap shareholder count, allow one class of stock, and generally bar foreign and entity owners. C corporations have none of those limits.
- Retaining earnings
- A C corporation that reinvests profit rather than distributing it can defer the second layer and may suit a capital-hungry growth company.
- Qualified small business stock
- Only C corporation stock can qualify for the gain exclusion available to certain small business shares held long enough.
The tax benefit
The right choice either removes a whole layer of tax or unlocks corporate-level planning and a potential exclusion on the eventual sale of stock.
Worked example
$200,000 of profit
An S corporation owner takes a $90,000 salary and receives $110,000 as distributions free of self-employment tax. A C corporation would tax the $200,000 at the corporate rate first and again on any dividend paid out.
Watch out for
- An unreasonably low salary is one of the most examined S corporation issues.
- Getting appreciated property out of a C corporation is expensive.
- State treatment varies; some states tax S corporations directly.
Terms from this topic
S corporationC corporationReasonable compensationDouble taxation
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