The Unfiltered Guide to Taxation of S Corp vs C Corp: How Entity Choice Impacts Your Bottom Line in 2026
Nearly every business owner, real estate investor, and ambitious 1099 contractor hits a wall with this decision: Is an S Corp or a C Corp truly the smarter play for your 2026 taxes? The wrong answer creates a chain of pain—double taxation, missed deductions, audit risk, or thousands in lost credits. But guided correctly, entity selection becomes a reliable lever that can add back $15,000 or more to your net income year after year.
Featured Snippet Answer: For 2026, S Corporations are pass-through entities, meaning profits flow to your personal return and avoid corporate-level tax, but require careful salary/draw compliance. C Corporations pay their own tax (flat 21%), offer broader deductions, but can trigger double taxation if profits are distributed to owners through dividends. Choosing the right entity impacts both annual cash flow and long-term tax exposure.
From a tax strategy standpoint, taxation of S Corp vs C Corp is less about “which pays less tax” and more about when income is taxed and who it’s taxed to. S Corps shift taxable income directly to the owner’s Form 1040, while C Corps create a separate tax layer under IRC §11. That timing difference alone can swing five figures annually depending on whether profits are distributed or retained.
How S Corps and C Corps Are Taxed Differently in 2026
The taxation of S Corp vs C Corp is a foundational decision with five- and six-figure consequences over your business’s lifespan. Starting with S Corps: S Corporations act as pass-through entities—net profit (income after expenses and a required “reasonable salary” to you, the owner) flows through to your personal Form 1040. There’s no federal entity-level tax, so you avoid the infamous “double taxation” on distributed earnings. However, California adds a 1.5% Franchise Tax on net income for S Corps, regardless of profit distribution (California Franchise Tax Board Form 100S).
C Corporations operate separately. They pay a flat federal corporate tax rate of 21% on net taxable income before any cash moves to you as the owner. If you take cash out as salary, you get a W-2 and pay individual tax rates, plus Social Security and Medicare. If you take dividends, that money is taxed again at your personal dividend rate, which for most high-earners in 2026 runs 15–23.8% federally, plus California state taxes. It’s classic double taxation.
For a direct comparison, let’s run the numbers on a company with $250,000 in profits:
- S Corp: $100,000 “reasonable salary” → subject to payroll tax, $150,000 leftover profit → no payroll tax, flows to 1040, only subject to income tax. CA Franchise Tax: $3,750 (1.5% x $250,000). No federal corporate tax.
- C Corp: $250,000 business profit taxed at 21% ($52,500 federal C Corp tax + California’s 8.84% corporate tax or $22,100), then any salary is deducted as an expense (W-2), but dividends out to owners get hit with capital gains/dividend tax. Remaining cash available to owner is significantly less after all layers.
The Optimal Persona for Each Structure: W-2, 1099, LLC, and Real Estate Investors
Picking a corporate structure is not academic—it’s a highly practical move that shapes how you pay yourself, which deductions are accessible, and how much you sacrifice to tax and compliance.
If you’re a high-earning business owner—LLC or 1099—with profits above $80,000, the S Corp delivers the quickest wins:
- Saves you 15.3% on all profit over “reasonable salary” (avoiding excess self-employment tax on distributions)
- Keeps compliance straightforward: File 1120S and K-1, maintain payroll records, avoid dividend and corporate double taxation
- Allows tailored retirement plans if you want to maximize pre-tax savings ($69,000+ SEP/Solo 401k for 2026, IRS Publication 560)
C Corps are optimal for real estate syndicates, startups seeking outside capital, and operations that want to retain large profits, use stock options, or plan for an exit strategy via sale. If you’re running a business that needs to reinvest six figures or more back each year—say, to accumulate working capital or fund R&D—C Corp status lets you hold profits at a lower flat rate (21%) and avoid triggering personal income tax on undistributed profits.
Strategic tax planning is crucial to avoid costly errors. Our tax planning services help business owners and investors identify the best structure before forming or restructuring their company. For a full deep dive, see our comprehensive S Corp tax guide.
KDA Case Study: From 1099 Contractor to S Corp—$19,800 First-Year Tax Swing
Let’s talk results. Tara, a freelance consultant in Orange County, moved from 1099 Schedule C income to a California S Corp with KDA’s guidance in 2025. With $180,000 in net profit, Tara used to pay self-employment tax on every dollar—and after running a $90,000 reasonable salary through payroll, she took $90,000 as distributions (no payroll tax). S Corp Franchise Tax ran $2,700. Final tally: $6,000 in S Corp payroll tax, $2,753 in franchise tax, and about $27,000 in federal income tax. In her previous 1099 setup, total taxes were climbing past $45,000. Switching to an S Corp structure reduced her taxes by $19,800 in the first year, net of setup and payroll costs ($4,000). That’s nearly a 5x ROI, before counting future retirement plan contributions.
Ready to see how we can help you? Explore more success stories on our case studies page to discover proven strategies that have saved our clients thousands in taxes.
What Most Owners Miss: The Salary Trap and Reasonable Compensation
One of the biggest S Corp audit triggers? Underpaying yourself on W-2. The IRS uses comparables and industry averages—see IRS S Corporation guidance—to decide if your S Corp salary is “reasonable.” Skimp here, and penalties reach 100% of underpaid payroll taxes, plus interest. For a solo software engineer making $200,000, a reasonable salary might be $110,000 (according to market data), so only the remaining $90,000 is shielded from self-employment tax. Don’t get greedy: KDA’s payroll studies keep you in a safe range.
C Corp owners run into the “accumulated earnings tax”—hoard more than $250,000 in retained earnings ($150,000 for PSCs), and your company is exposed to a 20% penalty. The IRS wants you to pay out earnings, not warehouse profits to defer personal income tax. The lesson: Only use a C Corp if you know why, and can defend your reinvestment rationale.
For practical cash planning, try this small business tax calculator to estimate your after-tax profit under both structures based on real California numbers.
Pro Tip: Franchise and State-Level Land Mines That Catch Out-of-State Owners Off Guard
California plays by its own rules. All S Corps (even out-of-state) must pay the minimum $800 franchise tax, plus 1.5% on net income. C Corps pay a flat 8.84% of income. And LLCs taxed as S Corps? They’re on the same hook. Don’t forget, if your S Corp or C Corp does business in multiple states, allocate and apportion carefully—otherwise, you might get double-taxed at the state level. See FTB Form 100S.
Keep your records laser-tight and link bookkeeping to each entity. Our bookkeeping and payroll team has untangled dozen-plus cases in 2025 alone where owners paid $3,000 to $9,500 more in state penalties after misreporting nexus. Don’t DIY your multistate setup—let our team get you compliant and save you from these hidden costs.
FAQ: S Corp vs C Corp Taxation—Your Next Questions Answered
What Actually Counts as a “Reasonable Salary”?
The IRS expects you to pay yourself what someone else would earn for similar work (formally, see IRS Topic No. 762). Factors include industry, geographic area, and role complexity. Underpaying is the fastest route to an S Corp audit.
Can You Switch From an S Corp to a C Corp (or Vice Versa)?
Yes, but timing and paperwork matter. Converting at the wrong time, or not cleaning up distributions first, can cause built-in gains tax or lock you into a higher tax scenario for five years (see Form 2553). Always consult a strategist before switching.
How Do Distributions Work in Each Structure?
S Corp: Distributions (after salary and payroll taxes) usually pass to you tax-free at the entity level, taxed once on your personal return. C Corp: Dividends from profits are taxed at the corporate level, then taxed again as qualified dividends on your 1040. If you expect to pull out all profits annually, S Corp usually wins.
Red Flag Alert: Why Generic “S Corp Election” Kits Often Backfire
Many online formation services rush new LLCs into S Corp status before profits justify the added complexity. If your net profit is under $60,000, S Corp savings are wiped out by payroll and compliance costs. Our experience is clear: Wait until net business profit—and your personal goals—truly align. If you’re not sure, book a custom tax review first.
Frequently Overlooked Write-Offs and Credits: S Corp and C Corp Owners
- S Corp: Health insurance premiums, accountable plans for expense reimbursement, Section 199A QBI deduction (up to 20% profit deduction if qualified, IRS Publication 535)
- C Corp: Deductible fringe benefits (group-term life up to $50,000, medical reimbursement plans, etc.), full deduction of charitable contributions up to 10% of taxable income in 2026
Be strategic about which entity owns high-depreciation assets—from vehicles to equipment to intellectual property. Properly structured, you can stack deductions and accelerate asset recovery (see IRS Publication 946).
This information is current as of 1/23/2026. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.
Book Your Custom Entity Tax Review—Don’t Leave $20K on the Table
Your corporate entity is not just a legal formality—it’s a tool to unlock or lose five figures a year. If you’re unsure whether your current structure is draining your profits, let’s analyze it together and surface savings, compliance fixes, or restructuring opportunities. Click here to book your strategy session now and reclaim what’s rightfully yours.
