C corp vs. S corp: when a C corporation may tax you less

The numbers

Picture a business earning $1,000,000 of profit after the owner’s salary, all of it reinvested in equipment, people, and growth. As an S corporation, the profit passes through to the owner, who we assume is in the 37% bracket and gets the full 20% qualified business income deduction. As a C corporation, the company pays tax on it.

For illustration purposes. Tax law may change, which may change these calculations slightly.

Federal tax on $1,000,000 of profit kept in the business

The C corporation pays $210,000 of business tax where the S corporation owner would pay $296,000 of personal tax, about $86,000 less each year while profits stay in the company. The catch comes when money comes out: if that profit is later paid as dividends, the owner owes personal tax of 23.8% on what’s left ($790,000), or about $188,020, at that time.

So a C corporation tends to win when profits stay in the business for years, when the owner plans a stock sale that may qualify for Section 1202, or when the owner will hold the stock until death. It tends to lose when the owner needs the profit to live on.

Oklahoma is figured separately and also differs by entity: Oklahoma taxes C corporations at 4%, while S corporation owners pay Oklahoma individual tax (up to 4.5%) or the 4.75% PTE tax if the company elects it.

How it works

1. Map where the profit goes. How much does the owner need to live on, and how much goes back into the business?
2. Model both structures. Federal and Oklahoma tax on salary, distributions, retained profit, and any dividends, year by year, kept separate for the business and for you.
3. Factor in the exit. A sale of C corporation stock may qualify for Section 1202. A sale of an S corporation is usually taxed once, as a pass-through.
4. Switch carefully, if at all. Revoking an S election or converting an LLC needs the right timing, paperwork, and owner consents.
5. Revisit every year. The answer changes as profit, payouts, and tax law change.

Who it fits

• Businesses with $1 million or more of profit that reinvest most of it.
• Founders planning a sale in five or more years who may qualify for Section 1202.
• Companies raising outside money, since investors often require a C corporation.

When an S corporation is still better

• Owners who take most of the profit out each year.
• Businesses that may be sold as an asset sale.
• Owners who use the Oklahoma PTE election and the QBI deduction well.

The rules

• Accumulated earnings tax. A C corporation that keeps profits beyond the reasonable needs of the business can owe an extra 20% tax. Plans for growth, equipment, and working capital should be documented. Most corporations can keep $250,000 without question.
• Personal holding companies. C corporations earning mostly passive income can face an extra tax.
• Five-year wait. After an S election is revoked or terminated, a new S election generally can’t be made for five years.
• Built-in gains. A C corporation that converts to an S corporation can owe corporate tax on gains built up before the conversion if assets are sold within five years.
• Reasonable compensation still matters. In either structure, owner salary must be reasonable.

Risks and costs to weigh

• Double tax on the way out. Dividends, and in an asset sale, gains, are taxed at the company and again to you.
• Losses stay in the company. C corporation losses don’t flow through to offset your other income.
• Rate risk. The 21% corporate rate is set by Congress and can change.

How we handle it for clients

With a Cannon & Brown tax plan, we model your entity choice year by year with your real numbers: what you take out, what you reinvest, how you might exit, and the federal and Oklahoma tax for the business and for you, shown separately. Because our technology keeps your books current all year, we can rerun the comparison whenever your plans change, instead of once a year at tax time. Your tax strategist reviews every recommendation.

Illustrative example. The business and figures on this page are hypothetical, used to explain how the strategy works. They are not a client and not a promise of results. The example assumes $1 million of profit after a reasonable owner salary, all of it retained, the owner in the 37% bracket with the full 20% qualified business income deduction, the 21% corporate rate, and dividends taxed at 20% plus 3.8%. This page is educational and is not tax or legal advice for your situation; tax rules and limits change.