S Corp vs C Corp: What Is the Difference for Taxes?

S corp vs C corp is a choice between two federal tax treatments of the same company. Under state law nothing changes: the business is a corporation, or an LLC taxed as one. The letters refer to subchapters of the Internal Revenue Code. A corporation is a C corporation for any year it is not an S corporation, and it becomes an S corporation only while an election under section 1362(a) is in effect (IRC 1361(a)). So the real question behind “corporation vs S corporation” is whether an eligible corporation should elect. If the business is still an LLC deciding how to be taxed, start with S corp vs LLC.

S corp vs C corp at a glance

How a C corporation is taxed: 21%, then a second tax on dividends

The corporate income tax is a flat 21% of taxable income, with no brackets (IRC 11(b)). The IRS describes what comes next plainly: a corporation's profit “is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax.” The corporation gets no deduction for the dividends it pays, and shareholders cannot deduct its losses (IRS, Forming a corporation).

Dividends from a domestic corporation are generally qualified dividend income, taxed at capital gains rates (IRC 1(h)(11)). Which rate applies depends on the shareholder's taxable income; the 2026 breakpoints are below. Dividends are also net investment income, so the 3.8% net investment income tax reaches the lesser of that income or modified AGI above $250,000 on a joint return, $200,000 for a single filer (IRC 1411).

Put the two layers together and the federal cost of paying profit out climbs quickly. The table follows $100 of corporate profit: $21 of corporate tax, then tax on the $79 dividend at the shareholder's rate.

Keeping profit in the company postpones the second layer until the earnings are paid out or the shareholder sells the stock. The Code limits open-ended retention: a corporation formed or availed of to avoid shareholder tax by letting earnings accumulate instead of distributing them can owe a 20% accumulated earnings tax (IRC 531; 532). Earnings kept for the reasonable needs of the business are credited against it, and a minimum credit covers accumulations up to $250,000, or $150,000 for corporations whose principal function is services in health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting (IRC 535(c)).

How an S corporation is taxed: once, through Schedule K-1

An S corporation generally pays no federal income tax (IRC 1363(a)). It files Form 1120-S and reports each shareholder's pro rata share of income, deductions and credits on Schedule K-1, and shareholders include those amounts on their own returns for the year whether or not the cash is distributed (IRC 1366(a)). The IRS sums up the result: shareholders “are assessed tax at their individual income tax rates,” which “allows S corporations to avoid double taxation on the corporate income” (IRS, S corporations).

Cash that later comes out is not taxed again. In a corporation with no earnings left from C corporation years, a distribution reduces the shareholder's stock basis and is taxable only to the extent it exceeds that basis (IRC 1368(b)). Losses run the other way: shareholders deduct them up to their stock and debt basis, and any excess carries forward (IRC 1366(d)). Two costs come with the single layer. Owners who work in the business need a reasonable salary through payroll before taking distributions, and that salary carries Social Security and Medicare tax; how the salary is set is covered in S corp vs LLC. And shareholders owe tax on profit the company keeps, so an owner can owe tax on cash that was reinvested.

Pass-through income also carries the QBI deduction. Owners of S corporations, partnerships and sole proprietorships can deduct up to 20% of qualified business income, while income earned through a C corporation does not qualify (IRC 199A; IRS QBI page). For 2026 the wage limits and the phase-out for service businesses begin above $201,750 of taxable income, or $403,500 on a joint return (Rev. Proc. 2025-32); the details are in the QBI deduction guide.

S corporation limits: who cannot elect

Only a small business corporation, as IRC 1361(b) defines it, can be an S corporation, and it has to keep qualifying:

• It is a domestic corporation, and not a financial institution using the reserve method for bad debts, an insurance company taxed under subchapter L, or a DISC or former DISC (IRC 1361(b)(2)).
• It has no more than 100 shareholders. A married couple counts as one, and so do all members of a family: a common ancestor, lineal descendants, and their spouses or former spouses, within six generations (IRC 1361(c)(1)).
• Every shareholder is an individual, an estate, an eligible trust or an eligible tax-exempt organization. A corporation, a partnership (including an investment fund organized as one) or a nonresident alien cannot hold a single share (IRC 1361(b)(1)(B), (C)).
• It has one class of stock. Shares may differ in voting rights, and debt that meets the straight debt safe harbor is not treated as a second class (IRC 1361(c)(4), (c)(5)).

Failing any test ends the election on the day it happens (IRC 1362(d)(2)). That is why the limits bite hardest when a company raises money: preferred stock with a liquidation preference, a fund organized as a partnership, or a nonresident alien or foreign corporation as an investor would each end S status.

When a C corporation fits better

Profit you plan to keep in the business

A C corporation pays 21% on profit it keeps. The same profit passed through to an owner is taxed at the owner's bracket, less the QBI deduction where it applies. For 2026 on a joint return, the 32% bracket starts above $403,550 of taxable income, 35% above $512,450 and 37% above $768,700 (Rev. Proc. 2025-32, section 4.01). Even a full 20% QBI deduction leaves 25.6%, 28% and 29.6% on profit in those brackets, all above 21%; in the 24% bracket a full deduction brings the rate to 19.2%, below it. The corporate rate wins only on current tax: the dividend tax, or tax on a gain when the stock is sold, still comes later, and the accumulated earnings tax limits how much can be kept without a business reason.

Outside investors and preferred stock

If an investor wants preferred stock, or invests through a fund organized as a partnership, an S corporation cannot take the money: it may have only one class of stock and no partnership or corporate shareholders (IRC 1361(b)). A C corporation has no federal limit on share classes or shareholder types, so it can issue preferred stock to a fund without losing its tax status.

The qualified small business stock exclusion (IRC 1202)

Section 1202 lets a shareholder other than a corporation exclude gain on qualified small business stock, and P.L. 119-21 (section 70431) widened it for stock acquired after July 4, 2025 (IRC 1202(a)(1), (a)(5), (a)(6); P.L. 119-21).

The stock must be issued by a domestic C corporation and acquired at original issue for money, property other than stock, or services (IRC 1202(c)(1)). During substantially all of the holding period, at least 80% of the corporation's assets by value must be used in the active conduct of a qualified trade or business, and the corporation must remain a C corporation (IRC 1202(c)(2), (e)(1)). Services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage do not qualify, and neither do businesses whose principal asset is the reputation or skill of employees, banking, insurance, financing, leasing, investing, farming, certain extraction businesses, or hotels and restaurants (IRC 1202(e)(3)). An S corporation cannot issue qualifying stock, and a C corporation that elects S status partway through the holding period puts the exclusion at risk.

S corp vs C corp taxes: the same $400,000 of profit

Paid out, the C corporation version costs $37,791 more this year. The company pays $50,090, then the owner pays 15% on the $188,435 dividend and $3,361 of net investment income tax, because modified AGI of $338,435 is above the $250,000 joint threshold. Together the two layers take 34.26% of the $238,525 the corporation earned after the salary. Kept in the company, the gap narrows to $6,165, but the $188,435 still faces dividend tax when it comes out, or tax on a gain if the stock is sold.

The QBI deduction carries the S corporation here. Without its $47,705 deduction, the S corporation column would total $93,664, more than the C corporation that keeps its profit. At higher incomes the comparison moves further toward the C corporation for retained profit, because the owner's bracket rises while the wage limits can shrink the QBI deduction, and a specified service business loses it entirely above the phase-in range. When the owners take the profit out every year, the second layer usually decides it for the S corporation.

Converting a C corporation to an S corporation

A C corporation becomes an S corporation by filing Form 2553 on time with every shareholder's consent; the deadlines, signatures and late-election relief are covered in the Form 2553 guide. The tax cost of the switch comes from the C corporation years:

• Built-in gains tax. Gain recognized during the 5-year recognition period that starts on the first day of the first S year, on assets the corporation held when it converted, is taxed to the corporation at 21%, the highest rate in IRC 11(b) (IRC 1374(a), (b)(1), (d)(7)). The total taxed is capped at the net unrealized built-in gain, the amount by which the assets' value exceeded their basis at conversion (IRC 1374(c)(2), (d)(1)). Income items that belong to C years count too (IRC 1374(d)(5)).
• Carryovers stay behind. Net operating losses and other carryforwards from C years cannot be used in S years (IRC 1371(b)(1)), except that C-year losses and business credit carryforwards can reduce the built-in gains tax (IRC 1374(b)(2), (b)(3)(B)).
• LIFO recapture. A corporation that used LIFO inventory in its last C year adds the LIFO recapture amount to that year's income, and the extra tax is payable in four equal installments (IRC 1363(d)).
• Leftover C corporation earnings. Distributions come first from the accumulated adjustments account and then as taxable dividends up to the old earnings (IRC 1368(c)). While those earnings remain, passive investment income above 25% of gross receipts triggers a 21% tax on excess net passive income (IRC 1375), and three consecutive such years end the election (IRC 1362(d)(3)).
• Estimated tax. The corporation makes estimated payments only if the built-in gains tax, the excess net passive income tax and investment credit recapture tax total $500 or more (Form 1120-S instructions).

Converting an S corp to a C corp

Going from S to C is simple to start and slow to reverse.

• Revocation. Shareholders holding more than half of the issued and outstanding shares, voting and nonvoting, consent (IRC 1362(d)(1)(B); Treas. Reg. 1.1362-6(a)(3)). A revocation made by the 15th day of the third month of the tax year takes effect on the first day of that year; one made later takes effect on the first day of the next year, unless it names a date on or after the day it is made (IRC 1362(d)(1)(C), (D)).
• Termination. The election also ends, on that date, when the corporation stops meeting the IRC 1361(b) tests, for example by issuing preferred stock to an investor (IRC 1362(d)(2)). A mid-year change splits the year into an S short year and a C short year (IRC 1362(e)).
• Five-year wait. After a revocation or termination, the corporation and any successor cannot elect S status again before its fifth tax year that begins after the first year the termination took effect, unless the IRS consents (IRC 1362(g)).
• Post-termination transition period. Until the later of one year after the last S day or the due date, with extensions, of the last S return, cash distributions reduce stock basis to the extent of the accumulated adjustments account, so previously taxed S profit can come out without dividend treatment (IRC 1377(b); IRC 1371(e)).
• LLCs. An LLC that elected S status was also treated as electing to be taxed as a corporation, and that classification stays after the S election ends (Treas. Reg. 301.7701-3(c)(1)(v)(C)). A revoking LLC is therefore a C corporation unless it also changes its classification on Form 8832.

Which is better for a small business, S corp or C corp?

State income and franchise taxes are not covered here and differ by state, so check your state tax agency before choosing. The choice also interacts with owner pay, estimated payments and year-end timing; the year-end tax planning checklist covers the moves that still work before December 31.

Sources: 26 U.S.C. 11, corporate income tax rate; 26 U.S.C. 1, including 1(h)(11) qualified dividends; 26 U.S.C. 1411, net investment income tax; IRS, Rev. Proc. 2025-32 (2026 rate tables and capital gains breakpoints); IRS, Forming a corporation; IRS, S corporations; 26 U.S.C. 162, trade or business expenses; 26 U.S.C. 199A, qualified business income; IRS, Qualified business income deduction; 26 U.S.C. 531, accumulated earnings tax; 26 U.S.C. 532, corporations subject to the accumulated earnings tax; 26 U.S.C. 535, accumulated taxable income and credit; 26 U.S.C. 1202, qualified small business stock; Public Law 119-21 (July 4, 2025), section 70431; 26 U.S.C. 1361, S corporation defined; 26 U.S.C. 1362, election, revocation, termination; 26 U.S.C. 1363, effect of election on the corporation; 26 U.S.C. 1366, pass-through to shareholders; 26 U.S.C. 1368, distributions; 26 U.S.C. 1371, coordination with subchapter C; 26 U.S.C. 1374, built-in gains tax; 26 U.S.C. 1375, excess net passive income tax; 26 U.S.C. 1377, post-termination transition period; IRS, Instructions for Form 1120-S (2025); IRS, Instructions for Form 2553 (Rev. December 2020); 26 CFR 1.1362-6, elections and consents; 26 CFR 301.7701-3, classification of certain business entities. Figures and rules checked against these sources on September 25, 2026. This is general information, not tax advice for your situation. Tax services are provided by licensed tax professionals under a separate engagement agreement. BEG does not provide tax advice.