A C corp pays a flat 21% federal tax on its profit, and shareholders are taxed again on dividends. An S corp is a tax election that passes profit through to its owners' personal returns, taxed once, but it allows only one class of stock and up to 100 US individual shareholders, which rules out venture funding.
The choice comes down to who will own the company and what it plans to do with its profit. Venture-backed startups are C corps because funds, preferred stock, and QSBS all require it. Profitable companies owned by a few US individuals often elect S corp status to cut payroll tax on owners' pay.
Venture funds can't own S corp stock, preferred stock isn't allowed in one, and only C corp stock can qualify for QSBS, so companies that take venture capital end up as C corps. A profitable company owned by a few US individuals usually pays less payroll tax with an S corp election.
Most venture-backed startups are Delaware C corps for that reason. Most profitable service businesses and bootstrapped companies with a handful of owners are S corps, or LLCs that elected S corp tax treatment.
A C corp is a separate taxpayer. It pays a flat 21% federal tax on its profit and files Form 1120. If it later pays that profit out as dividends, shareholders pay tax on the dividends too. That second layer is the "double taxation" people mention, and it only bites when profit leaves the company. A startup that reinvests everything, or loses money, mostly never feels it.
An S corp is a tax election, not a different kind of company. A corporation (or an LLC) files Form 2553 and from then on its profit and losses pass through to the owners' personal returns. The company files Form 1120-S, each owner gets a Schedule K-1, and the income is taxed once, at the owners' own rates.
The S corp payroll-tax saving comes from how owners get paid. An owner who works in the business has to take a reasonable salary, which carries payroll tax. Profit above that salary comes out as distributions, which don't. A sole proprietor or single-member LLC pays self-employment tax on all of it.
Three of the S corp rules rule it out the moment a priced round happens. Venture funds are partnerships, which can't own S corp stock. Preferred stock is a second class of stock, which an S corp can't have. And many funds have foreign or tax-exempt limited partners who need the fund to avoid pass-through income. Taking investment from a fund would break the S election automatically.
QSBS is the other reason. Stock in a C corp that meets the Section 1202 tests can exclude up to $15 million (or 10 times basis) of gain on a sale, and only C corp stock qualifies. For a founder who expects a large exit, that exclusion can be worth far more than any payroll-tax saving.
An S election can be made by filing Form 2553 no more than 2 months and 15 days after the start of the tax year it should apply to, signed by every shareholder. Late-election relief exists, but it's easier to file on time.
Going from S to C is common right before a first priced round. Revoking the election is quick, but you generally can't elect S status again for five years, and only stock issued after the company becomes a C corp can be QSBS. Moving from an LLC to a C corp is a bigger legal and tax event. Both are worth planning before a term sheet makes them urgent.
Simplified: ignores income tax brackets, the Social Security wage cap and state tax. The salary has to be reasonable for the work done; it's an IRS audit focus, not a number to minimize.
For a startup planning to raise venture capital, a C corp. Funds can't own S corp stock, preferred stock isn't allowed in an S corp, and only C corp stock can qualify for QSBS. For a profitable, owner-run company that won't take institutional money, an S corp election usually saves payroll tax.
Yes. An LLC can file Form 2553 to be taxed as an S corp while keeping its LLC legal structure. It then runs payroll for working owners and files Form 1120-S like any other S corp.
Yes, and many founders do. Revoking the S election is simple, but you generally can't re-elect S status for five years, and only stock issued after the switch can count as QSBS. Plan it with your CPA ahead of the round, not during it.
Yes. An S corp's profit is taxed once, on the owners' personal returns. A C corp's profit is taxed at the company at 21% and again when it's paid out as dividends, though a startup that reinvests its profit rarely pays dividends at all.
File Form 2553 no more than 2 months and 15 days after the start of the tax year you want it to apply to. A calendar-year company electing for 2027 would file by March 15, 2027. Every shareholder has to sign.
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