Hi , One of the biggest misconceptions I see is the belief that electing S corp status is a guaranteed tax saver. In reality, S corps can backfire for entrepreneurs who expect to retain earnings for reinvestment. Unlike a C corp, where profits can be reinvested at the corporate level, S corp owners are taxed personally on all profits whether or not they take distributions. We recently worked with a client who assumed S corp status would "shield" them from higher taxes, but they were shocked when they were taxed on earnings they never actually received in cash. For businesses planning to scale aggressively, seek outside investors, or eventually go public, a C corp structure is almost always a better fit. An S corp might look attractive in year one when profits are modest, but it can create unexpected tax burdens as retained earnings grow. My advice is don't fall for the myth that an S corp is the "automatic" smart move. Incorporation is about long-term strategy, not short-term savings, and the IRS makes sure costly missteps catch up with you.
My four decades managing a CPA practice and law firm, especially in tax and corporate law, have given me a unique perspective on business structuring. For new businesses, the initial choice between S-corp and C-corp hinges on your long-term vision, not just immediate profits. A C-corp is often a better fit if you foresee raising significant outside capital through diverse investors or plan for complex equity structures with different share classes. An S-corp suits simpler ownership structures, allowing profits and losses to pass through directly to avoid corporate-level taxation. Even with healthy profits, I'd advise against S-corp election if you anticipate substantial retained earnings for major future investments or significant asset accumulation within the business itself. The C-corp's lower corporate tax rate on these reinvested earnings can be a strategic advantage, particularly for large-scale physical expansions or significant real estate holdings. The biggest misconception about corporate tax savings is believing the initial election guarantees optimal savings without continuous, active tax planning and diligent compliance. Without ongoing legal and accounting guidance, businesses often miss opportunities or face penalties from changing regulations.
Choosing between S Corp and C Corp depends on many things, but can be generalized to three factors; size, intention of profits, and ownership earnings. First, an S Corp is limited to a maximum of 100 shareholders and all must be US citizens. From the get-go, that can make a business's decision easy, depending on the amount and location of their investors. Next, a business must decide if they are more interested in distributing the bulk of their profits to the shareholders or reinvesting the profits back into the company. If they will be distributing, S Corp will likely save tax dollars as profits are taxed once at the shareholder level, whereas C Corp distributions are taxed twice; once at the company level as profit and then again at the shareholder level as a distribution. This can be advantageous if the intention is to keep those profits in the company though, since C corp tax rates are likely lower than the shareholder's individual tax rates. Finally, ownership earnings must be considered since S Corp owners must take a reasonable salary. This opens them up to self-employment tax on that salary, but then any distributions above that would not be subject to self-employment tax. If profits are healthy enough to cover a reasonable salary and see tax benefits from the remaining distribution, this would be the right move. As always, a business must consider the cost of compliance (engaging with CPAs, lawyers, etc) when deciding if the tax savings from incorporating is worth it.
If you're small, U.S.-based, and want profits flowing straight to you tax-efficiently, an S-corp usually makes sense. If you're aiming to raise capital, bring in foreign or institutional investors, or reinvest profits for growth, a C-corp is the smarter play. The trap? Thinking the 21% C-corp rate is always cheaper, once you add dividend taxes, it's often more costly than an S-corp. It's less about tax tricks, more about how you plan to grow and take money out.
When selecting between an S corp and a C corp, ownership objectives, ownership structure, growth plans, and tax efficiency all factor into the decision. An S corp is often most appropriate for small to medium-sized business owners, with limited shareholders, who want to avoid "double taxation" and pass all profits to their owners. A C corp is often the best option for companies that intend to raise venture capital (VC) or issue more than one class of stock, or to go public, as those investors prefer the structure and feel more comfortable investing in a C corporation. I would discourage almost any business owner from electing S corp status if they have plans to heavily reinvest and grow profits in their companies, versus take that profit out. In a Subchapter S corporation, all income flows through to its shareholders, and those shareholders will be taxed on it, even if they did not take any cash out (meaning the entire amount flowed into their income). One of the biggest fallacies surrounding the tax savings of corporations is the idea that S corporations are always a lower tax structure. In the end, the savings for S corporations are dependent on how the business will compensate its owners, how the profits will be utilized, and what the plans are for growth. The right choice for a business owner requires balancing tax efficiency today and longer-term scalability.
If a business is structured around family ownership or a small circle of professionals, an S corporation usually makes the most sense because profits are taxed once through the personal return of shareholders. This will eliminate the hassle of filing the corporate tax returns and keep compliance costs lower. Conversely, a C corporation is a far better fit for companies contemplating capital raises from venture funds, multiple classes of shares, or international expansion because investors are far more comfortable with a C corporation. C corporations also allow flexibility to retain profits in the company, which S corporations cannot do. If profits are healthy, then I would not recommend the owners to choose S corporation status, whereby the owners do not want to receive distributions every year. An S corporation requires income to pass through, and shareholders still owe taxes on income they did not take out personally. In a C corporation, the retained earnings are taxed at the corporate level, but owners are not liable for taxes until a dividend is paid. This could be a critical difference if a company is trying to finance new projects, acquisitions, or substantial growth. The most common myth is that simply incorporating will automatically reduce your taxes. Some think that an S corporation is always less expensive, but in practice, professional fees, compliance costs, and ownership-salary can offset perceived savings. Some think a C corporation solely means "double tax," but in many situations, the flat corporate rate combined with a good reinvestment strategy can leave the business in a superior after-tax position.
How should a business choose between S corp and C corp at the start? When choosing an S corp vs. a C corp, consider your tax approach, and your overall objective. S corps are pass-through business entities. Any profits or losses are taxed on the owners' personal tax returns, and thus do not incur the tax at the corporate level that C corps do (currently at 21%). This means there is no double taxation of profits because, while the corporation pays tax on its profits, shareholders would incur taxes on dividends when they take their profits out of the business. On the other hand, C corps allow businesses to keep their profit at the corporate level, which can be beneficial if you would like to reinvest your profit for growth rather than take it out of the business immediately. Who is a better fit for C corp vs S corp, and why? C Corp is typically better for: 1. High-growth companies seeking venture capital or planning IPOs 2. Businesses wanting to retain earnings for expansion rather than distributing profits S Corp works best for: 1. Established, profitable businesses where owners want direct tax benefits 2. Family businesses or partnerships with simple ownership structures When would you advise a business owner not to elect S corp status even if profits are healthy? If a business is reinvesting all of its profits into growth, whether that be hiring, obtaining equipment, or conducting research and development, then electing S corp status may not be the best option even if it has profits to distribute. S corps must pass their profits to their owners' personal tax returns and be taxed at the individual income tax rates (up to 37% depending on taxable income). C corps do not have this distinction because their profits are only taxed at the corporate level at the flat rate of 21% with the business not until later having personal tax consequences to the shareholders after distributions. What is the biggest misconception about corporate tax savings? The biggest misconception is that corporate tax savings are solely about achieving the lowest possible statutory tax rate. In reality, an effective tax strategy is about a whole range of issues, not just the rate. An effective tax strategy involves the timing of income and deductions through specific methods of accounting, operationalizing the available tax credits (e.g. for R&D, green energy), maximizing all business deductions, and proactively considering how profits will be utilized in the long term.
When choosing early, I map profits and capital needs to the tax path. If we plan to raise outside money, offer preferred stock, or grant options to engineers, a C corp supports that from day one. If the company is owner-operated with steady income and few shareholders, an S corp may be a suitable choice because salary and distributions can be adjusted within the rules. The first thing I check is shareholder eligibility, the number of owners, and whether we need different classes of stock. I do not push S corp when we will reinvest most profits into inventory and marketing for several seasons. Retained earnings in a C corp can be taxed at the corporate rate until paid out, which keeps more cash on hand for growth. I also skip S corp if owners include a trust, another company, or a non-US person. What matters most is avoiding a later conversion when investors require preferred shares and standard option plans. The biggest misconception is that S corporation status is a tax hack that removes self-employment tax. S corporation owners must take reasonable compensation for active work. Pushing salaries too low increases the risk. Push salary up to actual market levels, and the advantage narrows. Another misconception is that the 21 percent C corp rate always wins. Add a dividend tax and a possible net investment tax, and the effective rate can climb. My rule of thumb is to forecast two distribution scenarios and one reinvestment scenario, then pick the highest after-tax cash outcome.