A C corp pays corporate income tax on its profits, and shareholders pay tax again when profits are paid out as dividends, which the IRS calls a double tax. An S corp is a corporation that elects, on Form 2553, to pass its income, losses, deductions and credits through to shareholders' personal returns, so profits are generally taxed once. The trade-off is strict eligibility: no more than 100 shareholders, one class of stock, and no partnerships, corporations or non-resident alien shareholders.
S corp and C corp aren't two different kinds of company you register with your state. They're two ways the IRS taxes a corporation. I read the IRS pages on S corporations, forming a corporation and Form 2553, and the SBA's guide to business structures, to set out what really differs and what founders get wrong.
S corp and C corp side by side
| C corp | S corp | |
|---|---|---|
| How profit is taxed | The corporation pays tax, then shareholders pay again on dividends | Profit passes through to shareholders at their individual rates |
| Who can own it | One or more people, without the S corp limits | Individuals, certain trusts and estates; no partnerships, corporations or non-resident aliens |
| Number of owners | One or more | No more than 100 shareholders (a married couple can count as one) |
| Classes of stock | Can have more than one | Only one |
| Federal income tax return | Form 1120 | Form 1120-S, with a Schedule K-1 for each shareholder |
| How you get the status | Incorporate with your state | Incorporate, then file Form 2553 signed by all shareholders |
| Losses | Shareholders can't deduct the corporation's losses | Some losses pass through to owners |
| Raising money | Can sell stock to investors; the SBA says it suits businesses planning to go public or be sold | Limited by the shareholder rules |
The Form 2553 deadline
This is where most S corp plans slip. The IRS instructions say you must file Form 2553 no more than 2 months and 15 days after the beginning of the tax year the election is to take effect, or at any time during the tax year before it. The IRS's own example makes it concrete: a calendar-year corporation that wants S status from January 1 must file by March 15. Miss the window and you're into the Relief for Late Elections procedure the instructions describe, which has its own paperwork.
Two smaller rules catch people too. The form must be signed by an authorised officer, and the IRS says an unsigned Form 2553 won't be considered timely filed. Every shareholder must also consent, which is why the form lists each shareholder's name and address. And for the 100 shareholder test, the IRS lets you count an individual and their spouse as one shareholder.
The salary rule S corp owners miss
The tax saving people talk about with S corps comes from taking some profit as distributions instead of wages. The IRS is clear about the limit: an S corporation must pay reasonable compensation to a shareholder-employee for the work they do before it makes non-wage distributions to them. The IRS also has the authority to reclassify payments from distributions, which aren't subject to employment taxes, to wages, which are, and it lists several court cases that back that up.
State tax can change the answer
The SBA points out that not all states tax S corps equally. Most recognise them the way the federal government does, but some tax S corps on profits above a set limit, and some don't recognise the S corp election at all and treat the business as a C corp. Check your own state before you count on the federal saving.
Which one to choose
- You're a small, profitable business owned by a few US individuals and you pay yourself a fair salary: an S corp election is worth working through with your accountant.
- You plan to raise money from investors, issue different share classes or bring in a company as an owner: a C corp, because an S corp can't do those things.
- You have, or expect, a non-US resident owner: a C corp, since non-resident aliens can't be S corp shareholders.
- You're losing money in the early years and want the losses on your own return: an S corp lets some losses pass through, while C corp shareholders can't deduct them.
- You're unsure: incorporate first and decide on the election inside the Form 2553 window.
If you're setting up from outside the US, read this on setting up a US LLC as a non-US resident before you choose, and this piece on incorporating your startup covers the wider decision.
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My advice on S corp or C corp
Decide on the money you'll take out and the owners you'll have, not on the label. If you'll pay yourself a reasonable salary, you're the only owners and you're all US individuals, look hard at the S corp election and diarise the 2 months and 15 days. If investors, share classes or overseas owners are in your plans, a C corp saves you a painful conversion later. Either way, sit down with an accountant before you file.
Frequently asked questions
Can an LLC be taxed as an S corp?
An entity eligible to be treated as a corporation can file Form 2553 to elect S corporation status, according to the IRS. Check the eligibility rules first, including the 100 shareholder limit and the single class of stock.
Can a non-US resident own an S corp?
No. The IRS says S corporation shareholders may not be non-resident aliens, along with partnerships and corporations.
What is the Form 2553 deadline?
No more than 2 months and 15 days after the beginning of the tax year the election should take effect, or at any time during the tax year before it.
Do C corps have to file electronically?
C corporations required to file 10 or more returns in a calendar year must e-file Form 1120, for returns required to be filed on or after January 1, 2024, according to the IRS.
