Certified Financial Planner (CFP) Tax Planning Practice Exam – Prep & Practice Test

The distinction between an S Corporation and a C Corporation primarily hinges on the tax designation and election under Subchapter S of the Internal Revenue Code. S Corporations are specifically designed to allow income, deductions, and credits to pass through to shareholders, thus avoiding double taxation at the corporate level, which is a hallmark characteristic of a C Corporation.

To operate as an S Corporation, a business must meet specific IRS requirements and submit a formal election (Form 2553) to opt for this status. This election is vital because it alters the way the corporation is taxed, ensuring that income is reported directly on the shareholders' personal tax returns instead of being taxed at the corporate level.

In contrast, C Corporations do not have such a restriction and are subject to corporate income tax on their profits, with dividends taxed again when distributed to shareholders. Therefore, the classification under Subchapter S is the primary factor that differentiates these two types of entities.