Difference Between S Corp and C Corp

You are standing at a major financial crossroads when you decide to move beyond a sole proprietorship or a simple LLC.

The structure you choose will influence how much tax you pay, how you compensate yourself, and even how attractive your business is to future investors. One of the most common questions we hear is about the difference between S Corp and C Corp , and the answer is hardly as simple as one being “better” than the other.

At Skyline Financial CPA, led by Zahra Samji, a licensed Houston CPA, we believe entity selection is not a “set it and forget it” decision. It is a strategic foundation that should evolve with your business.

In this guide, we will walk you through how each structure works, its rules, and the factors that can impact your long-term wealth.

A Basic Overview of the C-Corporation for New Businesses

A misconception you might have is that S-Corps and C-Corps are two completely different entities formed at the state level. In reality, every corporation starts as a C-corporation. An S-Corp is simply a special tax status you later elect with the IRS.

How C-Corporations Are Taxed

A C-Corp is a separate taxable entity. It files its own return on Form 1120 and pays federal income tax at a flat 21% corporate rate.

This structure can be appealing if your business plans to retain earnings for growth instead of distributing profits to owners.

The Double Taxation Reality

When a C-Corp distributes profits as dividends, the income is taxed twice:

Once at the corporate level.
Again, on your personal tax return.

While this sounds unfavorable, it can work well for high-growth companies that reinvest profits rather than paying dividends. In some cases, the flat 21% rate is lower than your personal marginal tax rate.

How S-Corporations Work for Business Owners

An infographic titled "S-Corporation Benefits" highlighting two main points and illustrating the difference between S and C corp: Tax Approach explains that profits and losses pass through to the owner's individual return, and Self-Employment Tax Advantage shows how owner compensation can be divided into W-2 salary and distributions, reducing self-employment tax.

An S-corp tax preparation is designed to avoid double taxation while still offering the legal protections of a corporation.

S-Corp Tax Approach

An S-Corp generally does not pay federal income tax at the entity level. Instead, profits and losses pass through to you and are reported on your individual return via Schedule K-1.

This pass-through structure is a major reason many small business owners explore the difference between S Corp and C Corp once their profits become consistent.

The Self-Employment Tax Advantage

The biggest benefit of an S-Corp is how it treats owner compensation. You can divide income into:

W-2 salary, which is subject to your payroll taxes.
Distributions, which are not subject to self-employment tax preparation.

When you structure it correctly, this can result in significant tax savings, especially for service-based businesses.

The Reasonable Salary Rule in S-Corporation Taxes

If you elect S-Corp status and pay yourself an unreasonably low salary while taking large distributions, the IRS may reclassify those distributions as wages. That can result in back taxes, penalties, and interest.

When we advise on an S Corp Election, we analyze industry benchmarks, your role, time commitment, and business profitability to arrive at a defensible salary that supports tax savings without inviting scrutiny.

The Impact of Section 1202 in a Successful Exit Strategy

Most business owners focus on annual tax savings and overlook what happens when they sell. This is where C-Corporations have a powerful and often ignored advantage.

Qualified Small Business Stock (QSBS)

Under Section 1202, if you own qualifying C-Corp stock for more than five years, you may be eligible for a significant tax benefit. You could exclude up to $10 million or 10 times your basis in capital gains when you sell.

If your long-term plan involves a major exit, choosing an S-Corp for short-term tax savings could cost you heavily in the future. This long-view analysis is a key part of evaluating the true difference between S Corp and C Corp.

Ownership and Investor Restrictions That Affect Your Options

Your growth plans have an important role in entity selection.

S-Corp Limitations

S-Corps come with strict IRS rules:

No more than 100 shareholders.
Shareholders must be U.S. citizens or resident aliens.
Only one class of stock.
No corporate or partnership shareholders.

These rules can limit fundraising and expansion opportunities.

C-Corp Flexibility

C-Corps have none of these restrictions. They can issue multiple classes of stock, bring in foreign investors, and attract venture capital.

If outside funding is in your future, a C-Corp is the only suitable choice.

A Guide List to Help You Decide Which Structure Fits Your Business

While your situation may differ, these common guidelines usually apply.

An S-Corp May Be Right If

You run a profitable service-based business.
You want to reduce self-employment taxes.
Ownership will remain small and domestic.
You want income to flow directly to your personal return.

A C-Corp May Be Better If

You plan to get investors or venture capital.
You want multiple classes of stock.
You intend to reinvest profits long-term.
You are targeting a large future exit.

Being clear on the difference between S and C corp in this context helps you prevent costly restructuring later.

Final Thoughts

It’s not just a tax decision that you make when choosing between an S-Corp and a C-Corp. It affects how you pay yourself, how you grow, and how you eventually exit your business.

At Skyline Financial CPA, we do not rely on generic advice. Houston CPA tax preparation Zahra works directly with you to evaluate your current profits, future plans, and risk tolerance so your entity structure supports your financial goals.

If you are weighing the difference between S and C corp and want clarity that is tailored to your business, reach out to Skyline Financial CPA now. With accounting services Houston, Houston bookkeeping services, and payroll services Houston TX, we provide the guidance and tools to make your business strategy both accurate and defensible.

Let us help you with entity selection and encourage you to make confident decisions.