S Corp vs. C Corp Overview: What’s the Difference?
First-time founders have an array of choices to make before their startup acquires its first customer. One of these decisions is whether to form as an LLC, corporation, or another type of business structure. Entrepreneurs who want to limit their personal liability and raise money from investors will likely choose to form as a corporation. That means they’ll be met with a new question: “Do I form as an S Corp, or a C Corp?”
At its base, a corporation is a business that’s considered a separate entity from its shareholders, who are the legal owners. They typically have a board of directors and issue stock to their investors. The choice between an S Corp and a C Corp is ultimately a tax election, as both are corporations in the eyes of state law. However, the IRS treats the two very differently. The type of corporation a business files as can have a significant impact on taxation, ownership, fundraising, and long-term growth strategy.
This guide breaks down how S Corps and C Corps work, their biggest differences, and the advantages of each. By the end, you’ll have a good picture of which tax treatment fits your business model and your growth trajectory. We’ll also look at Slash, a business banking platform that’s purpose-built to support new founders with flexible payment options, up to 2% cash back on card spend, and accounting integrations that simplify financial management.¹
What Is a C Corporation?
A C Corp is the default corporate structure under IRS rules. When you file articles of incorporation without making any additional tax election, your corporation is automatically classified as a C Corp. It’s a fully independent legal entity, capable of entering contracts, owning assets, and incurring debt separately from its owners. This type of corporation is called a C Corp because it’s taxed under Subchapter C of the IRS code. (You might be able to guess how an S Corp got its name).
C Corps provide limited liability protection for their shareholders and owners, meaning everyone’s personal assets are protected against lawsuits and debt collections. They’re also held to a number of compliance standards that require them to hold recurring meetings, file government reports, and pay certain fees and taxes.
From the IRS’s perspective, a C Corp is a separately taxable entity. C Corps pay corporate taxes via Form 1120, and shareholders pay income taxes on dividends they receive. This is called “double taxation”, and is one of the defining characteristics of this type of corporation.
C Corps can be owned by individuals, corporations, partnerships, and even foreign entities. There’s no limit to the number, type, or location of shareholders, which can make C Corps appealing to businesses that seek broad investor participation. A C Corp can also issue more than one class of stock, including common, preferred, and dividend stocks.
What Is an S Corporation?
An S Corporation is a class of corporation that’s made a specific tax election with the IRS through Form 2553. Some states also require a separate state-level S Corp election after incorporating. S Corps provide the same limited liability protection and come with the same compliance requirements as C Corps, but they don’t carry the same taxation rules.
S corps are called “pass-through taxation” entities. They file an informational federal return through Form 1120-S, but no income tax is actually paid at the corporate level. The profits and losses of the business are instead "passed through" to the business owners and reported on their personal tax returns. This single layer of taxation can represent significant tax savings for S Corps, especially for profitable businesses that make routine distributions to shareholders.
While S Corps come with a tax advantage, they also carry a set of eligibility restrictions that C Corps don't face. S Corps are limited to no more than 100 shareholders, and those shareholders must be US citizens or certain qualified trusts. This also means that S Corps can’t be owned by another entity like a C Corp; their owners are exclusively limited to U.S. residents. In some situations, it can be a challenge for an S Corp to obtain equity financing, as many venture capital and private equity funds are ineligible shareholders.
Side-by-Side Comparison: S Corp vs. C Corp
There’s a lot to keep track of when it comes to weighing S Corps and C Corps. Let’s take a closer look at the similarities and differences between the two, followed by a chart that compares them side-by-side:
Taxation Differences
A C Corp pays federal corporate income tax on its earnings, and if it distributes profits to shareholders as dividends, those shareholders pay personal income tax on those distributions as well. While this sort of double taxation can be costly, C Corps do get tax advantages in the form of broader deductions. They can deduct a range of business expenses like employee health insurance premiums and retirement plan contributions, which isn’t always possible among S Corps whose shareholders are also employees.
C Corps also gain tax advantages when forming in Delaware. Early in its lifecycle, a Delaware C Corp can actually account for its current losses in order to offset future gains. These losses are held at the corporate level and can generally be carried forward indefinitely to offset taxable income, helping to manage profitability over time.
Income from S Corps flows directly to shareholders' personal returns, and the business itself owes no federal income tax. This pass through taxation is valuable when shareholders receive regular distributions, as each dollar distributed avoids the corporate-level tax that a C Corp would have already paid. Shareholders in an S Corp can also deduct up to 20% of Qualified Business Income (QBI) on their tax returns, which often reduces an individual’s overall tax burden.
Ownership and Investment Flexibility
C Corporations offer greater capital-raising flexibility. They can issue multiple classes of stock to unlimited shareholders, allowing companies to offer preferred shares or tailored investment terms that suit strategic partners like venture capital investors. C Corps can also be owned by non-U.S. citizens and foreign entities, which opens the door for future acquisitions.
S Corporations are capped to 100 U.S.-based shareholders, which creates a couple problems. Because most venture capital funds and private equity firms are structured as LLCs or partnerships, they cannot legally be S Corp shareholders. S Corps are also ineligible for an Initial Public Offering (IPO), as any public dispersal of stock would quickly break through the 100 shareholder ceiling.
Governance and Compliance Requirements
State corporation laws make no distinction between C Corps and S Corps when it comes to compliance responsibilities. All corporations are required to follow corporate formalities and obligations, such as adopting bylaws, issuing stock, holding shareholder and director meetings, maintaining a registered agent and registered office, filing annual reports, and paying annual fees. The operational aspect of corporate compliance is nearly identical between C Corps and S Corps.
S Corps and C Corps: Advantages and Disadvantages
As you can see, there are plenty of differences between these two business structures. This can lead to a tough decision for businesses looking to choose between the two. Let’s clear things up by looking at some advantages and disadvantages:
C Corp Advantages
- Investment flexibility and growth potential: C Corps can raise capital from just about any investor, whether an individual, institutional fund, foreign national, or another business. There’s no shareholder cap, and the ability to issue multiple stock classes makes it possible to develop more complex deals.
- Retained earnings strategy: Instead of paying earnings out as dividends, C Corps can retain them, allowing capital to be reinvested and used to finance growth. The IRS allows C Corps to retain up to $250k of their profits each year without triggering double taxation.
- Employee benefit deductions: C Corps can widely deduct certain employee benefits, including health insurance premiums and qualified fringe benefits.
- Easy transfer of ownership: Shares can be freely sold or transferred to any eligible buyer, making IPOs and acquisitions possible.
C Corp Disadvantages
- Double taxation: Earnings are taxed at the corporate rate, and distributions are taxed again at the individual level as dividend income.
- Complex compliance requirements: C Corps must consistently update and store bylaws, shareholder lists, and board minutes in order to stay compliant. They also need to maintain a distinct board and officer roster, no matter the corporation’s headcount. Additionally, U.S. states often add their own reporting requirements.
- Less favorable for loss pass-through: All C Corp losses remain at the corporate level and cannot be used to offset shareholders' personal income.
S Corp Advantages
- Single layer of taxation: S Corps do not pay a corporate-level income tax, meaning any distribution of income to the shareholders is only taxed at the individual level.
- Self-employment tax benefits: S Corp owners can classify some of their income as salary and some as a distribution. Only their salary portion is subject to self-employment taxes, while remaining profits pass through to tax returns and are taxed at a lower rate.
- Pass-through of losses: The losses of an S corp pass through to its shareholders, who can use the losses to offset income, subject to tax law restrictions. This is often valuable in early stages when the startup is investing heavily and generating losses before reaching profitability.
S Corp Disadvantages
- Shareholder count and eligibility restrictions: An S Corp cannot have more than 100 shareholders, and its ability to raise capital from new investors is limited. This ceiling also means an S Corp can’t go public through an IPO.
- No preferred stock: Preferred stock can offer fixed dividends and priority claims on assets over common shareholders. Some veteran investors may highly value these privileges.
- Risk of termination. If an ineligible shareholder acquires stock, whether through inheritance or a secondary sale, the IRS can actually terminate a company’s S Corp election. For this reason, many S corps restrict their shareholders' ability to sell or transfer their shares.
- Limited growth trajectory. The restrictions that make S Corps efficient for small businesses can become obstacles as companies scale. Businesses targeting venture funding or an IPO often reach a dead end when they’re structured as S Corps.
Who Should Choose Each Type of Corporation
The decision between S Corp and C Corp largely comes down to two factors: the way you want to classify earnings in the short term, and the plan you have for your company in the long term. C Corps generally work best for founders who plan on creating a high-growth business that will rely on institutional investment. These companies often envision a future that includes an IPO, a complex ownership structure, and a wide range of investors with specific classes of stock. That future may also include an address in Delaware.
S Corps are typically right for founders who are looking to save on taxes while developing small to mid-sized U.S.-based businesses. Between pass-through taxation and self-employment benefits, S Corps offer savings opportunities that open up more capital in a startup’s early stages. The 100 shareholder limit may be perfectly acceptable for businesses with limited, stable ownership. Service-based businesses like law firms and marketing agencies are typically S Corps, as ownership structures are straightforward and expansion isn’t crucial.
With all this said – what if you change your mind? Is there a way to switch from one corporate structure to the other? In some cases, yes. With majority shareholder consent, S Corps can turn into C Corps by revoking their “S” election under Sec. 1362(a) with the IRS. C Corps can also turn into S Corps if they haven’t grown past a certain stage. As long as a C Corp has fewer than 101 U.S.-based shareholders and has only distributed one class of stock, it can switch to an S corp.
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When Should I Choose an LLC?
An LLC is a U.S. business structure that combines limited liability protection with "pass-through" taxation. It safeguards your personal assets from business debts/lawsuits. Owners, called "members," report profits on personal tax returns, avoiding the double taxation you get from a C Corp. That said, LLCs can actually elect to be taxed as a corporation if they so choose.
While LLCs have some features in common with S Corps, there are a few notable differences, including:
- S Corps require payroll for owner-employees, annual meetings, and stricter ownership rules, while LLCs do not.
- LLCs allow more than 100 shareholders, and they can be from outside the U.S.
- LLCs can issue more than one class of stock.
- S Corps get to enjoy self-employment tax savings that LLCs can’t take advantage of.
Your choice between the two can depend on the state you live in, the state you want to operate out of, how you want to raise money, and your goal for your business overall.
How Slash Can Transform Banking for Corporations of All Sizes
Whether you choose to form as an S Corp, C Corp, or LLC, starting a business from scratch can be a monumental challenge. This becomes even more complex when trying to adopt fractured platforms for accounting, payments, and banking that promise different things and don’t synchronize data. Slash is a business banking platform that brings that all together.
Slash gives early-stage businesses a strong financial foundation by enabling founders to actively track their cash flow and access analytics in real time. All payments, from employee card spend to B2B transfer, are automatically categorized and updated on the Slash dashboard. This can make it easier for new founders to stay organized and maintain compliance as their business grows.
Our platform offers a wide variety of payment rails, including RTP/FedNow, global ACH, domestic wires, and international SWIFT transfers. We also support stablecoins, which turn cryptocurrency into a digital asset that startups can rely on for business transactions.⁴ Slash allows users to hold, send, and receive USD-pegged stablecoins USDC and USDT across nine supported blockchains with dedicated on/off ramps.
Other Slash features that can offer tangible value to startups include:
- Streamlined integrations: With Slash, you can connect their financial records directly to QuickBooks, Xero, or Sage Intacct. You can also sync your Slash account with other third-party tools using Yodlee and Plaid integrations.
- Working capital financing: Slash’s working capital allows users to choose between flexible 30, 60, or 90 day repayment terms.⁵
- High yield treasury: Many treasury solutions are only available to well-established businesses. At Slash, users can earn 3.83% yield on their idle cash through treasury accounts backed by Morgan Stanley and BlackRock money market funds.⁶ The difference? Our users get instant access to our treasury accounts, with no minimum balance requirement.
- Slash Visa® Platinum Card: Earn up to 2% cash back on business expenses, set customizable spending controls and limits, and issue unlimited virtual cards for your team members, vendor payments, and subscriptions.
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Frequently Asked Questions
What happens if my S Corp loses eligibility?
If your S Corp loses eligibility, it reverts to a C Corp, which is the default filing state of a corporation. As a consequence, you’ll face double taxation and you’ll lose the ability to save on self-employment taxes.
What’s a sole proprietorship, and how is it different from a corporation?
A sole proprietorship is an unincorporated business structure owned and operated by one individual, where there is no legal separation between the owner and the business. The owner has full control, receives all profits, and is personally responsible for all debts and legal liabilities. It’s also a pass-through entity that’s subject to full self-employment tax. Sole proprietorships don’t have too much in common with corporations, and are best suited for individuals that aren’t looking to rapidly expand operations.
What are the costs associated with each structure?
Outside of tax structures, incorporating your business comes with its own costs, including variable state filing fees, professional service costs, annual report fees, and registered agent bills. Ultimately, C Corps tend to be a bit more costly and come with a couple extra compliance regulations, but it varies by state.
The Complete Guide to LLC Expenses and Tax Deductions
