This guide covers U.S. federal and state tax treatment for Australian founders, investors and businesses considering a U.S. structure. It does not cover Australian company tax rules.
We compare pass-through taxation, double taxation, owner pay, foreign ownership, fundraising, retained earnings, compliance and exit. Rates and thresholds change, so confirm current figures with the IRS and your state before acting.
Key Takeaways
- S Corps pass income through to shareholders; C Corps are taxed as separate taxpayers.
- No single S Corp tax rate applies; shareholder-level tax depends on personal circumstances.
- C Corp profits can be taxed twice, yet the structure suits reinvestment and outside investment.
- Direct nonresident alien shareholders can't hold S Corp stock, which rules it out for many Australians.
S Corp vs C Corp: Quick Comparison
| Feature | S Corp | C Corp |
|---|---|---|
| Profit tax | Flows to shareholders' personal returns | Corporation pays 21% federal tax |
| Distributions | Generally reduce stock basis; excess can be capital gain | Dividends taxed again at shareholder level |
| Owner pay | Reasonable salary required before distributions | Wages for owner-employees; dividends separate |
| Ownership | Up to 100 eligible shareholders, one class of stock | Broad: preferred stock, institutions, VCs |
| Retained cash | Income taxed to owners even if retained | Taxed at corporate level; accumulated earnings rules apply |
The federal corporate rate sits at 21% under IRC section 11. For S Corp owners, income is taxed at individual rates, including income that was never paid out in cash. State rules layer on top. California, for example, charges S Corps 1.5% on California-source income, so federal S status doesn't eliminate entity-level tax.
What Are S Corp and C Corp?
S Corp: Definition, Tax Mechanics and Eligibility
An S Corp is a U.S. federal tax election, not a separate entity type under state law. An eligible corporation or LLC files Form 2553, signed by all shareholders, generally within 2 months and 15 days of the start of the election year.
The corporation files Form 1120-S. Schedule K-1 then allocates profits, losses, deductions and credits to each shareholder, whether or not cash changes hands.
Pay and distributions:
- Working shareholders must take reasonable compensation before non-wage distributions
- The IRS can reclassify distributions as wages subject to employment tax
- The IRS compensation guidance offers no universal salary formula
- Distributions are tax-free only up to stock basis
Eligibility is where Australians most often stumble:
- U.S. domestic corporation only
- No more than 100 shareholders
- Only individuals, estates, certain exempt organisations and qualifying trusts
- No direct nonresident alien shareholders
- One class of stock (voting differences allowed if distribution rights are identical)
- Banks using the bad-debt reserve method, insurance companies and DISCs are excluded
Australian citizenship alone neither qualifies nor disqualifies an owner. U.S. tax residency (a green card or the substantial presence test) is what counts. An Australian company cannot be a direct S shareholder.
C Corp: Definition, Tax Mechanics and Common Use Cases
A C Corp is taxed separately from its owners. It files Form 1120 and pays tax on its own taxable income, even when it distributes nothing.
Profits face tax when earned and again when paid as dividends. Salaries are deductible to the company, and retained profits face no shareholder tax until distributed.
Qualified dividends carry maximum federal rates of 0%, 15% or 20% for U.S. residents, plus a possible 3.8% net investment income tax.
C Corps dominate growth businesses. Carta reported that about 9 in 10 C Corp startups on its platform incorporate in Delaware. Professional investors generally prefer C Corps because they can issue preferred stock and face fewer ownership limits.
Qualified small business stock (section 1202) is another draw. For stock acquired after 4 July 2025, gain exclusion is 50% at 3 years, 75% at 4 years and 100% at 5 years, with a cap of the greater of $15M or 10 times basis.
Expect governance, recordkeeping, payroll and annual filings, plus state taxes. Delaware franchise tax runs from a $175 minimum up to $200,000.
A cross-border caution. An Australian-owned U.S. company may also face:
- Form 5472 reporting, with a $25,000 penalty for failure to file
- 30% withholding on U.S.-source dividends, reduced by treaty
- Permanent establishment questions
- Transfer pricing under section 482
The Australia-U.S. treaty limits dividend withholding to 15% generally, 5% for qualifying corporate holders of 10% or more of voting power, and 0% in narrow cases. Treaty benefits are not automatic.
S Corp vs C Corp: Which Is Better for Your Business?
Compare total expected tax and compliance cost, not one headline rate against another. Treat statutory, marginal, blended and effective rates as distinct concepts. A 21% corporate rate is statutory; the real burden depends on what happens to the profit afterwards.
Profit Distribution Policy
An owner who pulls out most profits each year sees one layer of tax in an S Corp. The same owner in a C Corp pays corporate tax, then dividend tax.
A business that retains profits for hiring, inventory, research or acquisitions reverses that outcome. S Corp owners pay tax on income they never received, while a C Corp pays 21% and defers shareholder tax.
Retention has limits. The accumulated earnings tax is 20% where profits build up to avoid shareholder tax, with reasonable business needs as the test.
Owner Circumstances
Residence, personal brackets, other income, salary level, basis and the timing of distributions all matter. The section 199A deduction, now permanent, gives eligible pass-through owners up to 20% off qualified business income, though reasonable compensation is excluded.
Funding and Ownership
S Corp limits can block Australian investors, institutions, preferred shares, employee equity and venture capital. If a fundraising round is likely, a C Corp usually removes friction.
Exit and Restructuring
- C Corp stock sale: shareholder gain, potentially excluded under section 1202
- C Corp asset sale or liquidation: corporate gain plus shareholder tax
- S Corp asset sale: gains generally pass through, though section 1374 built-in gains tax can apply
- S to C conversion: revocation needs consent of holders of over half the shares; re-electing S status is generally barred for five years
- C to S: a 5-year recognition period can tax built-in gains at 21%
Situational Guidance
Consider an S Corp only when:
- Every shareholder qualifies
- Owner pay is handled correctly
- Pass-through treatment suits the owners' tax position
Consider a C Corp when outside investment, broad ownership, retained earnings or employee equity matter more than minimising current owner-level tax.
Australian founders who remain Australian tax residents, or who have an Australian parent company, should get a U.S. and cross-border review first.
Real-World Scenarios and Tax Planning Lessons
Owner-Operated S Corp: David E. Watson, P.C.
In Watson v. United States, an Eighth Circuit case from 2012, the S Corp paid its owner $24,000 in wages in each of 2002 and 2003, while distributing $203,651 and $175,470 in profits. The court upheld a reasonable-compensation finding of $91,044 and the resulting employment tax.
The lesson: S Corp savings depend on defensible salary. These are historical case figures, not current benchmarks.
Growth Company: Google's Financing
Google raised $25M in 1999 from Sequoia Capital and Kleiner Perkins, and its 2004 S-1 stated it had never paid cash dividends and intended to retain future earnings. Its tax classification is not stated in that filing, so treat this as a financing and retention illustration. Outside capital and retained earnings are the pattern where C Corps typically fit.
The Takeaway
Headline rates tell you little. Salary, distributions, investors and exit shape the outcome. Australian businesses weighing U.S. expansion, accounting structure or ongoing compliance can discuss their circumstances with VJM Global's cross-border accounting and advisory team.
Conclusion
An S Corp can suit an eligible, closely held, owner-operated business wanting pass-through treatment. A C Corp better supports reinvestment, outside capital, broader ownership and employee equity. Current federal and state rules, plus the owners' cross-border position, decide the result.
Before forming or converting, model projected tax, salary, distributions, retained earnings, compliance costs and exit outcomes. Then get qualified U.S. tax and cross-border advice.
Frequently Asked Questions
Why C Corp instead of S Corp?
A C Corp suits venture capital, foreign or institutional owners, multiple share classes, employee equity and retained earnings. It can be the better fit even when S pass-through treatment looks cheaper.
What are the tax consequences of converting an S corporation to a C corporation?
Taxation shifts from pass-through to corporate level. Post-termination distribution rules under section 1371(e) may apply, and re-electing S status is generally restricted for five years. Have a professional review the transition.
What is the main tax difference between an S Corp and a C Corp?
An S Corp passes income to shareholders' personal returns. A C Corp pays its own tax, and dividends may be taxed again. No single universal rate applies to S Corps.
Can an Australian citizen or foreign owner hold shares in an S Corp?
Not directly as a nonresident alien. U.S. tax residency, not citizenship, is the test. Check the owner's residency and entity structure before electing.
Are C Corp profits taxed twice?
Generally yes: once when earned and again when distributed as dividends. Outcomes vary if profits are retained, paid as deductible compensation or liquidated.
