Trap 6 · The double tax · From Chapter 9
S-Corp vs C-Corp: Avoiding Double Tax
An S corporation generally pays no entity-level income tax — profit passes through to shareholders under §1363 — while a C corporation pays tax at 21% under §11 and its shareholders pay again on dividends. Pick the wrong regime and the same dollar gets taxed twice.
| S-corp (§1363) | C-corp (§11) | |
|---|---|---|
| Entity tax | None (passthrough) | 21% flat |
| Owner tax | Once, at owner rates | Again, on dividends |
| Distributions | Generally tax-free (basis) | Taxable dividends |
| Best when | Profits flow to owners | Profits fund growth |
The passthrough
Section 1363(a) exempts the S corporation itself from income tax, with narrow exceptions: income, deductions, and credits flow through to shareholders and are taxed once, at the owner level. Distributions of already-taxed earnings generally come out without a second tax.
The entity tax
Section 11(b) taxes C corporations at a flat 21% on taxable income — and dividends from after-tax profit are taxed again to the shareholders who receive them. Double taxation is the default design of subchapter C, not an accident.
When C wins
When profits stay inside the company to fund growth, a single 21% toll can beat passthrough rates — and some companies cannot elect S at all. More than 100 shareholders, an ineligible owner, or a second class of stock keeps the election off the table: see S Election Eligibility. Converting later is possible, but appreciated assets can trigger the Built-In Gains Tax.
Trap questions, answered
- Is an S-corp always better than a C-corp?
- No — S treatment avoids a second tax on distributed profit, but a C-corp’s 21% rate can win when earnings stay in the company to fund growth.
- What is double taxation, exactly?
- The C-corp pays 21% on its profit, then shareholders pay tax again on dividends from the same profit. S-corp income is generally taxed once, to the shareholder.
- Can I switch from C to S later?
- Yes, by electing S status — but built-in gains tax can apply to appreciated assets, so time the election before value piles up.
The law: 26 U.S.C. § 1363 · 26 U.S.C. § 11 · Chapter 9
From the practice: Entity choice is a facts-and-figures call
The other traps: Reasonable Compensation · Distributions vs Salary · S Election Eligibility · Built-In Gains Tax