TEXAS BUSINESS LAW
C-Corp vs. S-Corp: What's the Difference?
A C corporation and an S corporation are not two different entities — they are the same corporation taxed two different ways. Every corporation starts as a “C corp” by default and pays tax at the entity level. By filing an election with the IRS, an eligible corporation becomes an “S corp” and is taxed as a pass-through, avoiding the double tax — but it takes on strict limits on who can own it and how its stock is structured. Choosing between them is mainly a tax decision, with ownership consequences attached.
What They Have in Common
Because both are corporations, they share the same legal foundation. Both are separate legal entities created by filing formation documents with the state. Both give shareholders limited liability, so owners are generally not personally responsible for business debts. And both run on the same internal machinery — shareholders, directors, and officers — and must observe corporate formalities like adopting bylaws, issuing stock, and holding meetings. The difference is not how they are organized; it is how they are taxed and who is allowed to own them.
The Tax Difference
This is the heart of the matter. A C corporation is a separately taxable entity: it files its own return and pays corporate income tax on its profits. When it distributes profits to shareholders as dividends, the shareholders pay tax again on their personal returns — the familiar double taxation.
An S corporation is taxed like a pass-through, similar to an LLC. The corporation files an informational return but pays no federal corporate income tax. Profits and losses flow through to the shareholders, who report them on their personal returns. There is only one layer of tax. One related wrinkle: an S corporation generally cannot deduct the cost of certain fringe benefits for shareholders who own more than 2% of the stock, while a C corporation can deduct those benefits.
The Ownership Limits on an S Corp
The S election is not available to everyone. To qualify and keep S status, a corporation must satisfy strict eligibility rules:
| Requirement | C corporation | S corporation |
|---|---|---|
| Entity-level income tax | Yes — taxed on profits | No — pass-through to owners |
| Double taxation on dividends | Yes | No |
| Maximum shareholders | Unlimited | 100 |
| Who may own shares | Almost anyone, including other entities | U.S. citizens or residents, certain trusts and estates — not corporations, partnerships, or nonresident aliens |
| Classes of stock | Multiple allowed | One class (voting differences are allowed) |
| How it’s created | Default on incorporation | Elect via IRS Form 2553 |
The shareholder cap, the citizenship and entity restrictions, and the single-class-of-stock rule are the constraints that most often disqualify a business — or force it back to C status when, say, it takes on an investor that is itself an entity.
How the S Election Works
A corporation becomes an S corp by filing IRS Form 2553. Timing matters: to take effect for the current tax year, the election generally must be filed no later than two months and 15 days after the start of that year — about March 15 for a calendar-year corporation — or at any time during the prior year. Texas imposes no separate state-level S election; the federal election is what changes the tax treatment. (Texas does not have a personal income tax, but S and C corporations are both subject to the Texas franchise tax.)
Which One Fits
There is no universally “better” choice. An S corp suits many closely held businesses that want liability protection without the second layer of tax and that comfortably meet the ownership limits. A C corp fits businesses that plan to raise outside capital from investors, issue multiple classes of stock, or retain earnings inside the company — flexibility that the S corp’s restrictions would block. Because the analysis blends tax and structure, it is worth modeling both before you commit. For the underlying entity, see what is a corporation; to compare against the pass-through alternative without corporate formalities, see what is an LLC.
Frequently Asked Questions
Is an S corporation a different entity than a C corporation?
No. Both are corporations under state law. “S” and “C” refer only to how the corporation is taxed federally. Filing IRS Form 2553 turns a C corporation into an S corporation for tax purposes.
What is the main advantage of an S corporation?
It avoids double taxation. Profits pass through to shareholders and are taxed once, rather than being taxed at the corporate level and again as dividends.
Who cannot own an S corporation?
S corporation shareholders must be U.S. citizens or residents and generally must be individuals (plus certain trusts and estates). Corporations, partnerships, and nonresident aliens cannot be shareholders, and the company is capped at 100 shareholders.
When is the S election deadline?
Generally two months and 15 days after the start of the tax year — about March 15 for a calendar-year corporation — though you can also elect in the prior year.
The C-corp/S-corp decision interacts with your ownership plans, your investors, and your tax picture, so it is best made before you incorporate or take on new owners. Reidel Law Firm advises Texas businesses on entity choice and S elections on a flat fee. Talk to a Texas business attorney about which fits your goals.
