Is a C corporation better than an S corporation in 2026?

It depends on whether the business retains or distributes earnings. The C corps 21% rate is attractive for retained earnings, especially if individual rates increased. But double taxation on distributions can eliminate the advantage. A comprehensive analysis of your specific income and distribution patterns is necessary.

Does the S corporation still save employment taxes?

Yes. S corporation distributions remain exempt from self-employment and Medicare taxes regardless of rate changes. For high-income business owners, this saves approximately 3.8% on the distribution amount, which can be tens of thousands of dollars annually.

Tax Planning in the New Landscape: Entity Selection Reconsidered | Lynch Law

Tax Planning in the New Landscape: Entity Selection Reconsidered

Lynch Law, PLLC

The start of 2026 is the right time to revisit one of the most fundamental questions in business tax planning: which entity type produces the best tax result? The answer depends on the current rate structure, the availability of the Section 199A deduction, the owner's plans for the business, and a host of other factors that may have shifted with the legislative changes taking effect this year.

The C Corporation Calculation

The C corporation's flat 21% rate has been unchanged by the TCJA sunset—it was enacted as a permanent rate reduction, not a temporary one. This means the C corporation's first layer of tax remains at 21% regardless of what happened to the individual rates. If individual rates increased (due to TCJA sunset), the relative advantage of the C corporation's lower rate on retained earnings grows. However, the double taxation of distributed earnings—corporate tax plus dividend tax—must always be factored in.^[1]

The S Corporation Calculation

S corporation income passes through to the shareholders and is taxed at their individual rates. If the TCJA rates expired and the top rate returned to 39.6%, the effective tax rate on S corporation income increases correspondingly. If the Section 199A deduction also expired, the effective rate increases further because the 20% deduction that previously reduced the effective rate on pass-through income is no longer available. At the new effective rates, the S corporation may lose its traditional tax advantage over the C corporation for owners who retain earnings in the business.^[2]

The Employment Tax Factor

One advantage that the S corporation retains regardless of rate changes is the ability to split income between salary (subject to employment taxes) and distributions (not subject to employment taxes). This self-employment tax savings remains significant—approximately 2.9% of the distribution amount for Medicare taxes, plus the 0.9% additional Medicare tax for high-income taxpayers. The reasonable compensation requirement limits this benefit, but for many business owners the employment tax savings alone justifies the S corporation structure.^[3]

Partnership and LLC Considerations

LLCs taxed as partnerships offer the greatest flexibility in allocating income and losses among owners but do not provide the employment tax benefits of the S corporation. Partnership taxation is particularly advantageous for real estate ventures (due to the ability to specially allocate depreciation and losses), for businesses with multiple classes of ownership interests, and for businesses that plan to bring in new equity investors. The loss of Section 199A does not affect the allocation flexibility advantages of partnership taxation.^[4]

Making the Decision

Entity selection is not a one-time decision—it should be revisited whenever the tax landscape changes, which is exactly what has happened entering 2026. Business owners should model the total tax cost under each entity type using their actual income projections for 2026, taking into account federal and state income taxes, employment taxes, the availability (or absence) of the 199A deduction, and the planned use of the earnings (retained vs. distributed). Consulting with experienced tax counsel is essential—the wrong entity choice can cost thousands of dollars per year in unnecessary taxes.^[5]

References

^[1] IRC § 11(b) (C corporation flat 21% rate; permanent under TCJA § 13001); double taxation of distributions under §§ 301, 1(h)(11).
^[2] S corporation pass-through income taxed at individual rates under IRC § 1366; loss of § 199A increases effective rate on pass-through income.
^[3] S corporation distributions not subject to self-employment tax; IRC § 1402(a)(2) (limited partner exception); reasonable compensation requirement under Rev. Rul. 74-44.
^[4] IRC § 704(a) (partnership allocation flexibility); partnerships advantageous for real estate, multi-class ownership, and equity investor structures.
^[5] See Tax Controversy & IRS Defense (discussing entity selection analysis and tax planning for the 2026 environment).

This article is for informational purposes only and does not constitute legal advice. The facts of every situation are different, and you should consult with a qualified attorney before taking action based on the information in this article.