A corporation is called a C-corporation if it is taxed under Subchapter C of the Internal Revenue Code and an S-corporation if it is taxed under Subchapter S of the Internal Revenue Code. Both are considered legal entities or artificial persons separate and distinct from their owners/shareholders. This means that a corporation can open a bank account, own property and do business, all under its own name. Below are discussed some of the key differences between S-corporations and C-corporations.

Taxation: C-corporations and S corporations are taxed differently for federal income tax purposes. S-corporations are commonly referred to as “pass-through” entities for tax purposes. In other words, similar to a partnership, an S-corporation’s income is passed through to its owners and reported on the owners’ personal income tax returns, thereby eliminating the double taxation incurred by owners of C-corporations.

C-corporations are taxed as separate entities. Income earned by a C-corporation is normally taxed at the corporate level at the corporation’s tax rate. After the C-corporation pays its corporate income tax on its business income, any distributions made to its shareholders (owners) are taxed again as dividends at the shareholder’s tax rate. For some, this potential for double taxation makes a C-corporation undesirable.

However, not all of a C-corporation’s profits will be subject to double taxation. The operators of the corporation may be compensated with reasonable salaries. Except for applicable payroll taxes such as FICA, these salaries are deductible by the corporation as an expense and are therefore, free from tax at the corporate level. The recipients of these salaries, however, will have to pay income tax and their share of the FICA tax. In some situations, salaries to the owners may offset a C-corporation’s entire net profit and the corporation will owe no taxes.

Number of Owners: C-Corporations can have an unlimited number of shareholders while S Corporations are restricted to no more than 75 shareholders.

Ownership by Non-U.S. Residents: Non-resident aliens can be owners of C Corporations while non-resident aliens may not own S Corporations.

Ownership by Other Entities: S Corporations cannot be owned by C Corporations, other S Corporations, many trusts, limited liability companies, or partnerships. However, C corporations are not subject to these restrictions.

Division of Profits: S-corporations have no flexibility in how their profits are distributed amongst the owners. Profits must be distributed according to the ratio of stock ownership, notwithstanding the fact that the owners themselves believe that it would be more equitable to distribute the profits differently. (Note: Nothing would preclude an S-corporation from paying those shareholders believed more deserving a salary in addition to their share of distributed profits.)

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