Choosing between an LLC, C-Corporation, and S-Corporation is one of the most important early decisions for your business. Each has radically different tax treatment, ownership restrictions, investor compatibility, and complexity. I'll walk you through the detailed comparison, show you when to convert from one to another, and provide an interactive decision wizard to help you choose the optimal structure based on your specific situation.
Most popular for small businesses & real estate (flexibility + simplicity)
Required for VC funding & IPO; 98% of funded startups
Best for profitable service businesses ($60K+ net income)
C-Corps eligible for $10M+ tax-free gains (Section 1202)
Best for: Small businesses, real estate, freelancers, partnerships
Key features:
Tax: Pass-through (1040 Schedule C/E or 1065 + K-1s)
Complexity: Low
Best for: VC-backed startups, companies seeking IPO, high-growth tech
Key features:
Tax: Corporate (Form 1120) + personal (dividends/capital gains)
Complexity: High
Best for: Profitable service businesses, consultants, agencies ($60K+ net income)
Key features:
Tax: Pass-through (Form 1120-S + K-1s), payroll required
Complexity: Moderate
Many founders incorporate as a Delaware C-Corp on day one because "that's what startups do." But if you're not raising VC money immediately, you're paying for unnecessary complexity (corporate formalities, double taxation if you take profits) with no benefit. Start as an LLC; convert to C-Corp 6-12 months before your first institutional funding round. Timing matters for QSBS (5-year clock starts at issuance).
| Feature | LLC | C-Corporation | S-Corporation |
|---|---|---|---|
| Taxation | Pass-through (default). Taxed once on member's 1040 (Schedule C/E or K-1) | Double taxation: corporate (21%) + personal (15-20% capital gains or 37% dividends) | Pass-through. Taxed once on shareholder's 1040 (K-1), but must pay reasonable salary (payroll tax) |
| Self-Employment Tax | All profits subject to 15.3% SE tax (unless electing S-Corp) | N/A (corporate entity). Shareholders pay payroll tax only on W-2 salary | Only W-2 salary subject to payroll tax; distributions are not (tax savings) |
| Ownership Restrictions | None. Unlimited members of any type (individuals, entities, foreigners) | None. Unlimited shareholders of any type (VCs, institutions, foreign investors) | Max 100 shareholders; must be U.S. citizens/residents; no entity shareholders (except certain trusts) |
| Stock Classes | Flexible "membership interests"; can allocate profits/losses however you want | Multiple classes allowed (common, preferred). Essential for VC funding (liquidation preferences, anti-dilution) | One class of stock only. No preferred stock allowed |
| VC / Investor Compatibility | ❌ VCs will not invest in LLCs (tax/structural issues) | ✅ Required for VC funding. 98% of funded startups are DE C-Corps | ❌ VCs will not invest (one-class restriction, 100-shareholder limit) |
| Stock Options (ISOs/NSOs) | ❌ Cannot issue stock options (profits interests instead, but less favorable) | ✅ Full ISO and NSO support; standard for employee equity | ✅ Can issue stock options, but limited appeal due to one-class restriction |
| QSBS Eligibility (Section 1202) | ❌ Not eligible | ✅ Eligible. $10M+ capital gains tax-free if held 5+ years | ❌ Not eligible |
| Profit Distribution Rules | Flexible. Can distribute disproportionately (e.g., sweat equity partner gets 50% profits but owns 10%) | Must distribute dividends pro-rata by share ownership | Must distribute pro-rata (one class of stock) |
| Formalities / Compliance | Minimal. Operating agreement, annual reports. No board meetings required (though recommended) | Heavy. Board meetings, stockholder meetings, minutes, 83(b) elections, 409A valuations, Delaware franchise tax | Moderate. Board meetings, payroll (W-2 for owner), reasonable compensation analysis, annual S-Corp election maintenance |
| Perpetual Existence | Can be structured for perpetual existence or dissolution triggers (member death, etc.) | Perpetual existence by default (unless dissolved) | Perpetual existence (but S-Corp election can be lost if rules violated) |
| Transferability of Ownership | Restricted by operating agreement (typically requires member consent) | Freely transferable (unless restricted by bylaws/shareholder agreement) | Restricted (must maintain S-Corp eligibility; can't transfer to ineligible shareholders) |
| Best State to Form | Wyoming (asset protection, low cost) or Delaware (if VC-track) | Delaware (Court of Chancery, VC standard, well-developed law) | Any state (S-Corp is federal tax election, not state-level entity) |
| When to Choose | Small business, real estate, partnerships, freelancers, no VC plans | Seeking VC funding, planning IPO, issuing stock options, QSBS planning | Profitable service business ($60K+ net), want SE tax savings, no investor plans |
Tax status: Disregarded entity (default). You report LLC income/expenses directly on your personal 1040 using Schedule C (business) or Schedule E (rental real estate).
Example: Your SMLLC earns $100K net profit. You report the full $100K on Schedule C of your 1040. You owe:
No separate LLC tax return. The LLC is "invisible" for tax purposes.
Tax status: Partnership (default). The LLC files Form 1065 (partnership return) and issues Schedule K-1 to each member showing their share of profit/loss. Members report K-1 income on their personal 1040.
Example: MMLLC earns $200K. Two members: 60% / 40% split. LLC files Form 1065 showing $200K profit. Member A receives K-1 showing $120K; Member B receives K-1 showing $80K. Each reports their K-1 income on 1040 and owes income tax + SE tax on their share.
Benefit: Can allocate profits/losses disproportionately (e.g., sweat equity partner gets 50% profits but only 10% ownership).
Layer 1 (Corporate): The C-Corp pays 21% federal corporate income tax on profits (Form 1120).
Layer 2 (Personal): When the corporation distributes dividends to shareholders, they pay 15-20% capital gains tax (or up to 37% on ordinary dividends).
Example: C-Corp earns $100K profit.
Early-stage startups rarely distribute profits. Instead, they reinvest everything into growth (hiring, R&D, marketing). No distributions = no second layer of tax. The double taxation only hits upon exit (acquisition or IPO), and by then, QSBS or capital gains treatment makes it favorable. Plus, VCs require C-Corp structure, so it's non-negotiable.
Mechanic: S-Corp is pass-through (like LLC), but you're required to pay yourself a "reasonable salary" as a W-2 employee. Only the salary is subject to payroll tax (15.3%). Remaining profit is distributed as a dividend (not subject to SE tax).
Example: S-Corp earns $100K profit. You pay yourself $60K salary (W-2). Remaining $40K distributed as S-Corp dividend.
Compare to LLC: If this were an LLC, the full $100K would be subject to SE tax ($15,300 vs $9,180). Savings: $6,120/year.
You cannot pay yourself $20K salary and take $80K in distributions to avoid payroll tax. The IRS requires "reasonable compensation" for services performed. Rule of thumb: salary should be 50-70% of profit for owner-operators. If audited, IRS can reclassify distributions as wages and assess back payroll taxes + penalties.
S-Corp saves ~15.3% SE tax on the portion of profit taken as distributions (vs salary). But S-Corp adds costs:
General rule: S-Corp election is worth it if your net business income exceeds $60K-80K/year. Below that, the tax savings don't justify the added complexity and cost.
You can form an LLC (for flexibility and asset protection) and elect S-Corp taxation (for SE tax savings). This is called "check-the-box" election (Form 2553). You get:
I recommend this for most profitable service businesses: Form a Wyoming or Delaware LLC, elect S-Corp tax status when profit exceeds $60K.
Bottom line: If you want institutional funding, you must be a C-Corp. 98% of VC-backed companies are Delaware C-Corps.
| Question | LLC | C-Corp | S-Corp |
|---|---|---|---|
| Max # of Owners | Unlimited | Unlimited | 100 shareholders max |
| Foreign Owners Allowed? | ✅ Yes | ✅ Yes | ❌ No (only U.S. citizens/residents) |
| Entity Owners Allowed? | ✅ Yes (LLCs, corps, trusts) | ✅ Yes | ❌ No (only individuals + certain trusts) |
| VC Funds Can Invest? | ❌ No | ✅ Yes | ❌ No |
| Can Issue Preferred Stock? | ❌ No (membership interests only) | ✅ Yes (multiple classes) | ❌ No (one class only) |
| Stock Options (ISOs/NSOs)? | ❌ No (profits interests instead) | ✅ Yes (full ISO/NSO support) | ✅ Yes (but limited utility) |
LLCs cannot issue stock options. Instead, you grant "profits interests" (a future profit share that vests over time). These are less favorable than stock options:
Bottom line: If you need to grant equity to employees, C-Corp or S-Corp is better.
C-Corps can issue:
Why this matters: Top talent expects stock options. C-Corp structure allows you to compete for employees with equity-based comp.
S-Corps can issue stock options, but they're less attractive:
Practical impact: S-Corps work for small, U.S.-based teams but don't scale well for equity comp.
If you hold C-Corp stock for 5+ years, you can exclude up to $10 million in capital gains from federal tax (or 10x your basis, whichever is greater). This is a massive benefit for founders.
Requirements:
Example: You found a C-Corp, own 100% at formation (stock basis: $0). After 7 years, you sell for $15M. With QSBS:
This is why founders form C-Corps early: The 5-year clock starts at stock issuance. If you wait until year 3 to convert from LLC to C-Corp, your QSBS clock doesn't start until year 3—you won't hit 5 years by typical exit timelines.
Many businesses start as one entity type and convert to another as they grow. Understanding the mechanics, timing, and tax implications is critical.
Ideal timing: 6-12 months before your first institutional funding round. This gives you:
Don't wait until: The week before your seed round closes. You'll be rushed, make mistakes, and potentially lose QSBS benefits.
Tax-free conversion under IRC Section 351: LLC members transfer their membership interests to a newly formed C-Corp in exchange for stock. If done correctly, this is tax-free.
Steps:
Timing: Must be done before raising from VCs. VCs will not invest into an LLC.
The 5-year QSBS holding period starts when stock is issued. If you form your LLC today and convert to C-Corp in year 3, your QSBS clock starts at year 3. If you exit in year 6 (total), you've only held C-Corp stock for 3 years—no QSBS. Solution: Form C-Corp early (even if pre-revenue) if you have serious exit potential, or convert within first 12-18 months.
Ideal candidate: Profitable service business (consulting, agency, SaaS) earning $60K+ net income annually.
How it works: You keep your LLC legal structure but elect to be taxed as an S-Corp (Form 2553 with IRS). This is "check-the-box" taxation—you don't form a new entity.
Benefits:
Form 2553 must be filed by March 15 (for calendar-year businesses) or within 2 months and 15 days of forming the LLC to be effective for the current tax year. Miss the deadline? Election applies to the following year. I see this mistake constantly—file early to avoid losing a full year of tax savings.
If you formed as an S-Corp (or LLC electing S-Corp) and later want to raise VC money, you must convert to C-Corp.
How to convert:
Tax consequence: May trigger built-in gains tax if S-Corp has appreciated assets. Consult CPA before converting.
This is treated as a liquidation of the C-Corp—triggering immediate tax on all appreciated assets at the corporate level, plus personal tax on distributions. Extremely expensive.
Example: C-Corp has $1M in appreciated assets (basis: $100K). You liquidate to convert to LLC. Corp owes tax on $900K gain (~$189K). Shareholders then owe tax on distribution (~$180K). Total tax: ~$369K just to change entity type.
When it might make sense: Very early stage (pre-revenue, no assets), and you realize you don't need C-Corp structure. But even then, usually better to just keep the C-Corp dormant and start fresh with an LLC for a different venture.
Why:
Tax optimization: If net income exceeds $60K, elect S-Corp status to save self-employment tax.
I form: Wyoming LLC ($100 filing + $60/year) for lowest cost and strong asset protection.
Pros:
Cons:
Pros:
Cons:
If you're 80%+ sure you'll raise VC within 24 months, form Delaware C-Corp now. If you're unsure or bootstrapping, start with LLC and convert to C-Corp 6-12 months before fundraising. The conversion is straightforward if done early (before complex cap table).
Structure: One LLC per property (or series LLC with protected series for each property).
Why LLC:
Why Wyoming: Strongest asset protection, no state income tax, lowest annual fees ($60/year + small asset fee).
Do NOT use: C-Corp (double taxation) or S-Corp (passive income disqualifies S-Corp status).
Why Delaware:
Why C-Corp (not LLC/S-Corp):
Tax note: Early-stage C-Corps don't pay dividends (reinvest all profit), so double taxation is deferred until exit (acquisition/IPO).
Structure: Form Wyoming or Delaware LLC, elect S-Corp status (Form 2553).
Why this combination:
Example tax savings: $200K net income. Pay yourself $120K salary (W-2), take $80K distribution. Save ~$12,240/year in SE tax vs pure LLC.
Cost: Payroll processing (~$1,000/year) + extra accounting (~$500/year). Net savings: ~$10,700/year.
Do NOT use: C-Corp (double taxation unnecessary for service business with no investor plans).
Why:
If profitable ($60K+ each): Elect S-Corp status to save SE tax.
Key documents:
LLC pros:
Sole proprietorship (no entity) pros:
When to form LLC: Once revenue exceeds $20K/year or liability risk is real (physical products, contracts, employees). Until then, sole proprietorship may be fine.
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I help clients choose and form the optimal entity structure for their business. Services include:
$800–$1,200 (complete setup)
Timeline: 1-2 weeks
$1,500–$2,500 (Delaware C-Corp)
Timeline: 2-3 weeks
$400–$600 (for existing LLC)
Deadline: March 15 (or 2 mo. + 15 days from formation)
$1,500–$2,500
$600–$1,000
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