C-Corp vs. S-Corp: How to Choose
Both are corporations. The difference is how they are taxed, and that difference has cascading implications for your growth strategy, compensation planning, and exit options.
5 min readA C-Corp pays corporate income tax on its earnings, and shareholders pay tax again on dividends, creating double taxation. An S-Corp avoids double taxation by passing income through to shareholders' personal returns. However, S-Corps have restrictions on ownership that C-Corps do not, making C-Corps the standard choice for venture-backed companies and businesses planning to go public. The right choice depends on your capital raising plans, ownership structure, and long-term exit strategy.
Understanding your options
C-Corp
A C corporation is the default tax classification for corporations. It pays federal corporate income tax on its earnings, and shareholders pay personal income tax on dividends received. This double taxation is the most commonly cited disadvantage, but C-Corps offer unlimited growth potential, flexible ownership structures, and are the standard entity for venture capital investment and public markets.
S-Corp
An S corporation is a tax election that allows qualifying corporations to pass income through to shareholders' personal tax returns, avoiding corporate-level taxation. S-Corps face restrictions on the number and type of shareholders, cannot have more than one class of stock, and must pay reasonable salaries to shareholder-employees. The S-Corp election is available to both corporations and LLCs.
C-Corp vs. S-Corp
Corporate-level tax plus shareholder-level tax on dividends (double taxation)
Pass-through taxation; income taxed only at the shareholder level
Subject to the federal corporate income tax rate on all earnings
No entity-level tax; income passes through to shareholders
No limit on number or type of shareholders
Maximum 100 shareholders; no non-resident aliens; certain entity types excluded
Can issue multiple classes of stock (common, preferred, etc.)
One class of stock only (though voting and non-voting shares are permitted)
Standard structure for VC investment due to preferred stock flexibility
Generally not compatible with VC investment due to ownership and stock restrictions
Shareholders who are employees pay employment taxes on wages only
Shareholders who are employees pay employment taxes on wages; distributions are not subject to employment taxes
Can retain earnings in the company for reinvestment
All income passes through to shareholders regardless of whether distributed
Corporate losses stay at the entity level
Losses pass through and can offset shareholders' other income (within basis limits)
Asset sales may create two levels of tax; stock sales are taxed at shareholder level
Generally one level of tax on sale; certain advantages for asset sales
Standard structure for IPOs and public companies
Must revoke S election before going public
When to choose each option
When to choose C-Corp
A C-Corp structure is typically the right choice when you plan to raise venture capital or institutional investment that requires preferred stock, when you plan to go public or position for acquisition by a public company, when you want to retain significant earnings in the company for reinvestment rather than distributing them, when you anticipate having foreign shareholders, corporate shareholders, or more than 100 investors, and when the business benefits from corporate-level tax planning strategies like the qualified small business stock exclusion.
When to choose S-Corp
The S-Corp election is typically advantageous when the business is privately held with a small number of domestic individual shareholders, when avoiding double taxation on distributed earnings is a priority, when the owner-operators want to minimize self-employment taxes on business income above their reasonable salary, when the business does not plan to raise venture capital or issue multiple classes of stock, and when the business generates losses that shareholders want to deduct against their other personal income.
Myths vs. reality
C-Corps always pay more total tax than S-Corps
With the current federal corporate rate, a C-Corp that retains and reinvests earnings may actually have a lower effective tax rate than an S-Corp that passes all income through to shareholders in higher individual tax brackets. The math depends on your specific situation.
You can easily switch from C-Corp to S-Corp or vice versa
Converting from C-Corp to S-Corp can trigger built-in gains taxes on appreciated assets for a defined period. Converting from S-Corp to C-Corp is simpler but irreversible for a period of years. These transitions require careful planning and tax analysis.
S-Corps cannot pay dividends
S-Corps can and do make distributions to shareholders. The difference is that these distributions are generally not subject to an additional level of tax because the income has already been taxed at the shareholder level through pass-through.
All startups should be C-Corps
Only startups planning to raise venture capital typically need C-Corp status. Bootstrapped businesses, service companies, and lifestyle businesses often benefit more from S-Corp pass-through taxation.
What to remember
- The fundamental difference is taxation: C-Corps face double taxation while S-Corps provide pass-through treatment
- C-Corps are the standard for venture-backed companies because they accommodate preferred stock and unlimited shareholders
- S-Corps are advantageous for privately held businesses seeking to avoid double taxation and reduce self-employment taxes
- S-Corp eligibility has strict requirements: maximum 100 shareholders, one class of stock, domestic individual shareholders
- Retained earnings are treated differently. C-Corps can reinvest without triggering shareholder-level tax; S-Corp income passes through regardless
- Conversion between C-Corp and S-Corp has tax consequences that require professional analysis
- The right choice depends on your capital raising plans, exit strategy, and ownership structure, not on a general rule
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