LLC vs C-Corp: which, when, and why

The simple version

A C-corp is a separate taxpayer. Profits are taxed at the federal corporate rate — 21% flat under the Tax Cuts and Jobs Act, unchanged through 2026 — and then taxed again when profits are distributed to shareholders as dividends. That is the famous "double taxation."

The mechanical difference is well understood. The interesting question is when paying twice is worth it. The answer is narrower than most founders assume, but wider than it was two years ago — the One Big Beautiful Bill Act of 2025 materially expanded the qualified small business stock exclusion, which is the one scenario where C-corp double taxation can legitimately beat pass-through arithmetic.

How each structure gets taxed

LLC (default treatment)

• Single-member LLC: disregarded; profit flows to owner's Schedule C
• Multi-member LLC: partnership; profit flows through K-1 to each member
• Federal tax: owner's personal bracket, 10–37% on 2026 income tax brackets
• Self-employment tax: 15.3% on active business income up to the $184,500 Social Security wage base, 2.9% Medicare thereafter
• Qualified business income deduction: up to 20% under Section 199A
• State tax: typically pass-through, with a handful of states imposing franchise or gross-receipts taxes

C-corp

• Federal corporate income tax: 21% flat under IRC §11, with no brackets
• State corporate income tax: 0% to ~12%, per the Tax Foundation state corporate rates data
• Dividend distributions: taxed to shareholders at 0%, 15%, or 20% (qualified dividend rates), plus potential 3.8% net investment income tax
• Shareholder salary: deductible to corporation, taxable as ordinary income to recipient, subject to payroll tax
• No QBI deduction — that is a pass-through benefit
• No self-employment tax on the corporation, but payroll tax applies to any salaries paid

For an owner-operated business with $250,000 in profit distributed in full, the aggregated federal rate comes out to roughly 36–40% under a C-corp structure (21% corporate + 15–20% qualified dividend on what remains), versus 30–35% as a pass-through LLC after QBI. That is the baseline "double taxation penalty" — real, but smaller than the sticker rates suggest.

When the C-corp is the right answer

1. You are raising venture capital

This is the dominant reason C-corps exist in the early-stage startup world. Venture capital funds are structured as limited partnerships whose investors include tax-exempt entities (pensions, endowments, foundations). Those investors cannot take on unrelated business taxable income from an operating pass-through — which is what a VC fund investing in an LLC would generate.

The practical effect: essentially every institutional venture fund requires you to be a Delaware C-corp before they will wire funds. Y Combinator's standard safe documents assume a Delaware C-corp. Most major accelerators assume it. If your 18-month plan includes a priced equity round, starting as a Delaware C-corp avoids the $5,000–$15,000 conversion cost and the tax-planning complexity of an LLC-to-C-corp flip.

The conversion itself is usually accomplished through a statutory conversion or an F-reorganization, is generally not a taxable event when done properly, and preserves the original EIN. But "not a taxable event" is not the same as "cheap" — you pay lawyers, and you need to scrub the cap table for pre-conversion profits interests, vesting issues, and §83(b) timing.

2. You qualify for §1202 qualified small business stock (QSBS)

Section 1202 allows shareholders of a qualified C-corp to exclude gain on sale of stock held long enough, up to a generous cap. The 2025 One Big Beautiful Bill Act materially rewrote §1202 for stock issued after July 4, 2025:

• Tiered holding periods: 50% exclusion at 3 years, 75% at 4 years, 100% at 5+ years (previously all-or-nothing at 5 years)
• Cap increase: greater of $15 million or 10× adjusted basis (previously $10 million), indexed for inflation from 2027
• Asset threshold increase: aggregate gross assets at issuance up to $75 million (previously $50 million), indexed for inflation from 2027
• Transition rule: pre-July-4-2025 stock keeps its old-rules treatment

QSBS is only available on stock in a C-corp — pass-through entities cannot issue qualified small business stock. For founders who plan to hold for five years and sell, the §1202 exclusion can be worth millions. A founder who sells $10 million of QSBS after five years pays federal capital gains tax of zero on that amount. That is the single most powerful tax benefit in the code for early-stage founders — and it is C-corp-only.

For pre-OBBBA context and the revised rules in context, see tax-practice coverage of the OBBBA's Section 1202 changes and the §1202 statute itself.

3. You want to issue employee stock options

Incentive stock options (ISOs) are a corporate-only instrument under IRC §422. Non-qualified stock options (NSOs) can in principle be issued by an LLC, but the granting mechanics are significantly more complex and tax-disadvantaged. If your compensation plan depends on recruiting engineers with stock options, the C-corp is the standard instrument and the path of least resistance.

LLCs use profits interests instead — grants of the right to future appreciation — which work cleanly under Rev. Proc. 93-27 and Rev. Proc. 2001-43. But most employees do not understand profits interests, and most lawyers in this space default to corporate grants.

4. You are accumulating capital inside the business

The pass-through arithmetic that makes an LLC so attractive at low-to-moderate profit levels starts to break down when profits substantially exceed personal consumption needs. LLC profits are taxed to the owner in the year earned, regardless of whether they are distributed — meaning a profitable LLC that wants to retain earnings for growth is forcing its owners into the top personal bracket on money they never received.

A C-corp at 21% keeps retained earnings in the business at a lower rate than the owner's personal bracket above roughly $100,000–$200,000 in personal income. The "accumulated earnings tax" at §531 limits how long a corporation can sit on undistributed cash without a business purpose, but the practical limit — $250,000 retained for most businesses, $150,000 for personal service corporations — is generous enough to matter for growing companies.

This is the classic "capital-intensive small business that reinvests everything" scenario. Manufacturing, equipment-heavy trades, and some real-estate-adjacent operating businesses (though real estate itself is almost always better in an LLC) can benefit.

5. Your ownership structure cannot be held by a pass-through

S-corps have strict shareholder rules — no foreign shareholders, no corporate or partnership shareholders, no more than 100 shareholders, single class of stock. If you have international co-founders, a holding company that wants to own the business, or a cap table with preferred-share investors, the S-corp election is unavailable, which pushes you toward default LLC partnership treatment or a C-corp.

Between the two, the C-corp is often the cleaner choice at scale because it accommodates preferred stock, ESOPs, and non-U.S. investors without special structuring.

When the LLC is the right answer

• The business is an operating business with no venture-capital plans. Consulting practices, agencies, e-commerce stores, local service businesses, and most SaaS bootstrapped to $1–5M in revenue are usually best as LLCs.
• You plan to distribute most profits each year. The double-taxation penalty is a real drag on distributed earnings; the pass-through arithmetic wins.
• You own real estate. An LLC holding appreciated property can generally distribute the property to members without triggering gain. A C-corp holding appreciated property triggers tax at the corporate level on distribution or sale. Real estate inside a C-corp is a well-known mistake.
• You want flexible allocations among members. LLCs can allocate profits, losses, and specific items disproportionately through partnership tax provisions. C-corps cannot.
• You want simplicity. One tax return, no board meetings, no stock certificates, no corporate minutes. For a solo owner or small partnership, the administrative burden difference is meaningful.

Conversion paths

LLC → C-corp

Three common mechanisms, with different tax consequences:

1. Statutory conversion (available in most states including Delaware). The LLC files a certificate of conversion with the state, and it becomes a corporation. One entity, continuous existence, same EIN. For federal tax purposes, this is generally treated as the LLC contributing its assets to a new corporation in exchange for stock under §351, then liquidating — typically tax-free if the §351 requirements are met.

2. Statutory merger (older mechanism, still common). The LLC merges into a newly formed corporation. Same tax result if structured correctly.

3. Contribution and dissolution. Members contribute LLC interests to a new corporation in exchange for stock, then dissolve the LLC. More paperwork but preserves tax attributes cleanly.

Cost: usually $5,000–$15,000 in legal fees for a straightforward conversion of a small LLC. More if there are complicated cap table issues, profits interests to clean up, or state-level nexus concerns. The QSBS clock starts on the date of C-corp issuance, not the date the LLC was formed — which is why founders planning a QSBS exit should convert sooner rather than later.

C-corp → LLC

This is much harder and usually expensive. The conversion is treated as a liquidation of the C-corp, triggering gain at both corporate and shareholder levels on any appreciated assets. Founders stuck in a C-corp that no longer makes sense often live with it rather than eat the conversion tax.

The 2026 numerical picture

Scenario	Best choice	Why
Solo consultant, $120K profit, fully distributed	LLC	Pass-through + QBI; SE-tax minor
Solo consultant, $120K profit, consistently above $80K	LLC + S-corp election	Saves self-employment tax
Venture-backed startup, any profit	Delaware C-corp	VC requirement, QSBS access
Bootstrapped SaaS, $2M profit, growing, considering exit	LLC now; evaluate C-corp conversion if exit in 5+ years	QSBS planning
Manufacturing shop reinvesting $300K/year	C-corp	Retained earnings at 21%
Rental real estate portfolio	LLC (never C-corp)	Appreciation trap in C-corp
Professional practice, single owner	LLC (PLLC where required) + S-corp election	SE-tax savings; no QSBS

FAQ

Can I have QSBS on an LLC? No. §1202 applies only to stock in a domestic C-corporation that meets the qualified-small-business requirements. Pass-through entities are categorically excluded.

Can a C-corp elect to be taxed as an S-corp? Yes — it's the same Form 2553 process. But an S-corp is still a pass-through, so the QSBS benefit goes away. Most C-corp-to-S-corp conversions happen in mature businesses that no longer need C-corp features.

If I form a C-corp, do I have to pay myself a salary? If you work for the business, yes, under the same "reasonable compensation" framework that applies to S-corps. The difference is that C-corp salary is deductible to the corporation at 21%, which can actually make salary more efficient than dividends for closely-held operating businesses.

Is Delaware always the right state for a C-corp? For venture-backed startups, yes — Delaware has the deepest body of corporate law, and investors expect it. For small operating businesses that will never raise outside capital, Delaware usually adds cost without benefit; forming in your home state is often better.

What about a B-corp? A B-corp is a subtype of C-corp (in most states; a few have separate statutes) with stakeholder-governance provisions. Tax treatment is identical to a normal C-corp. Choose it if the governance signaling matters; do not choose it expecting tax benefits.

Bottom line

For the vast majority of operating businesses that will never raise institutional capital, the LLC is the right structure and the question is not close. The C-corp costs more, taxes profits twice, and imposes formalities that don't serve single-owner or small-partnership businesses.

For venture-backed startups, the Delaware C-corp is the right structure and the question is also not close — the VC plumbing requires it, and QSBS is only available there.

The hard cases are in the middle: profitable bootstrapped businesses considering whether to convert to chase QSBS, capital-intensive operations weighing retained earnings, and founders planning an exit in the 5–10 year window. For those, the 2026 numbers — 21% corporate rate, expanded §1202 caps, permanent 20% QBI deduction — don't make the decision easy, but they do make the C-corp path more attractive than it has been in a decade.

Sources

• IRS Publication 542, Corporations
• IRS Publication 3402, Taxation of Limited Liability Companies
• IRS — S corporations
• IRS — Tax Cuts and Jobs Act comparison for businesses
• IRS — 2026 tax inflation adjustments
• 26 U.S.C. §1202 — Partial exclusion for gain from certain small business stock
• 26 U.S.C. §351 — Transfer to corporation controlled by transferor
• 26 U.S.C. §422 — Incentive stock options
• Rev. Proc. 93-27 — Profits interests
• Tax Foundation — State Corporate Income Tax Rates and Brackets, 2026
• Social Security Administration — Contribution and Benefit Base