Choosing Between an LLC and a Corporation

By Hank FasthoffJuly 5, 2026

Your choice between a limited liability company and a corporation affects governance, ownership rights, financing, and liability under state law. Federal tax treatment presents a separate decision. A Texas LLC can be taxed as a disregarded entity, partnership, S corporation, or C corporation, while a Texas corporation can be taxed as a C corporation or qualify for an S corporation election.

You should choose the state entity form and federal tax classification together. A business built for two owners who want flexible distributions presents different concerns from a company that plans to issue preferred stock to venture investors. You should account for tax rates, but ownership terms, future financing, compensation plans, and exit strategy often determine which structure fits.

State Entity Form and Federal Tax Classification

Texas law determines whether you formed an LLC or corporation. In the certificate of formation and governing documents, you establish who manages the entity, how owners vote, how economic rights are divided, and how ownership interests may be transferred.

Federal tax law classifies the entity for income tax purposes. A domestic LLC with one member is generally disregarded as separate from its owner, and a domestic LLC with two or more members is generally taxed as a partnership. An eligible LLC can elect corporate treatment. A qualifying LLC or corporation can elect S corporation treatment by filing Form 2553.

An LLC that files Form 2553 continues as an LLC under Texas law. It keeps its LLC certificate of formation and company agreement while using S corporation treatment for federal tax purposes. That distinction affects contracts, ownership documents, governance, and any subsequent sale or conversion.

LLC Tax Treatment

A sole owner generally reports the business activity of a disregarded LLC on the owner's federal return. An LLC with multiple members that is taxed as a partnership files Form 1065 and reports each member's share on a Schedule K-1. Income can be taxable to a member even when the LLC retains the cash.

Self-employment tax depends on the LLC's classification and the owner's role. A sole owner who operates a disregarded LLC generally pays self-employment tax on net earnings from the business. Members of an LLC taxed as a partnership face more detailed rules involving distributive shares, guaranteed payments, and the federal exception for limited partners.

For 2026, self-employment tax generally applies to 92.35% of net self-employment earnings. The 12.4% Social Security portion applies up to the 2026 taxable maximum of $184,500, and the 2.9% Medicare portion applies to all covered net earnings. A separate 0.9% Additional Medicare Tax can apply when wages and self-employment income exceed the statutory threshold for your filing status.

An LLC can elect S corporation treatment if it satisfies the eligibility rules. A shareholder who provides services must receive reasonable compensation for those services, and the wages are subject to employment taxes. Distributions may be reclassified as wages when compensation falls below a reasonable amount for the services performed. Payroll costs, unemployment taxes, retirement contributions, benefit treatment, state taxes, and the qualified business income deduction can affect whether the election produces a net benefit.

An LLC can elect C corporation treatment by filing Form 8832. That election may fit a business that wants corporate taxation without changing its Texas entity form, but some investors and equity plans depend on stock rights under state law that require a corporation.

C Corporation and S Corporation Tax Treatment

A C corporation pays federal income tax at 21% under Section 11 of the Internal Revenue Code. Shareholders can owe a second tax when the corporation distributes earnings as dividends. Qualified dividends receive federal rates of 0%, 15%, or 20% when the shareholder and dividend satisfy the applicable requirements, and the 3.8% net investment income tax can apply in addition.

You should compare the 21% corporate rate and individual rates together with payroll taxes, the qualified business income deduction, state taxes, the timing and character of distributions, the net investment income tax, retained earnings, and the tax consequences of a sale.

An S corporation generally passes income, deductions, gains, losses, and credits through to its shareholders. Eligibility is limited to a domestic corporation or eligible domestic entity with no more than 100 shareholders and one class of stock for distribution and liquidation rights. Eligible shareholders generally include U.S. citizens or resident individuals, estates, certain trusts, and certain exempt organizations, while voting rights may differ within the single class of stock.

A disqualifying event can terminate the federal S election. The entity form continues unchanged after the termination. Federal law provides relief for some inadvertent invalid elections and terminations, but the entity and its owners must qualify for that relief and correct the problem.

Limited Liability Under Texas Law

Texas corporations and LLCs generally separate entity obligations from owner obligations. Section 21.223 of the Texas Business Organizations Code limits shareholder liability for corporate contractual obligations, while Sections 101.002 and 101.114 apply related protections to LLC members and managers.

You can assume personal liability through a guaranty, become liable for your personal torts or statutory violations, receive an improper distribution, or face liability under another applicable rule. For certain contractual obligations, Section 21.223 requires actual fraud committed primarily for the owner's direct personal benefit before a claimant can impose liability through an alter ego or similar theory.

Section 21.223 bars shareholder liability for covered contractual obligations based on a corporation's failure to observe corporate formalities, and Section 101.002 applies that rule to LLCs. Separate accounts, accurate records, documented authority, and compliance with governing documents serve important tax, accounting, evidentiary, and fiduciary functions. A claimant must establish another legal basis for owner liability.

Governance and Ownership Rights

A Texas LLC uses a company agreement. Members can make the LLC member-managed or manager-managed, divide voting power separately from economic rights, create classes of membership interests, and define approval rights for financing, transfers, distributions, and a sale. That flexibility serves closely held companies whose owners want management and economics tailored to their relationship.

A Texas corporation uses a certificate of formation, bylaws, a board of directors, officers, and shareholder approvals for specified actions. Section 21.351 provides for an annual shareholder meeting, subject to the written consent provisions and the corporation's governing documents. Investors, directors, employees, and acquisition counsel commonly understand that governance structure.

You should spend as much effort on the governing documents as the certificate of formation. An LLC with two members and no buyout terms can become unmanageable after a deadlock. A corporation that issues founder stock without vesting can leave a departed founder with a permanent ownership block. The company agreement, bylaws, shareholder agreements, equity documents, and transfer restrictions govern the owners' business relationship within the chosen entity form.

Investment and Equity Compensation

Many venture capital and institutional investors prefer a Delaware C corporation. Preferred stock can provide liquidation preferences, conversion rights, protection against dilution, voting protections, and board rights through familiar documents. Some investment funds also avoid entities taxed as partnerships because that treatment can create K-1 reporting, unrelated business taxable income, or effectively connected income concerns for their investors.

An LLC can create preferred economic and governance rights through its company agreement. It can also issue membership interests, options, and profits interests. Those instruments use different tax and legal documents from corporate stock options or restricted stock units, so you should choose the compensation structure before promising employees a percentage of the company.

A corporation can adopt a stock plan and issue common stock, restricted stock, options, or other awards, subject to corporate, tax, securities, and contractual requirements. Incentive stock options under Section 422 are available only for qualifying corporate stock, although nonqualified options can cover corporate stock or an LLC interest if the arrangement satisfies the applicable tax rules.

Qualified Small Business Stock

A shareholder may exclude part or all of the gain from a sale of qualified small business stock under Section 1202 when the shareholder, corporation, stock issuance, active business, holding period, and other statutory requirements are satisfied. The exclusion applies only to qualifying C corporation stock.

Public Law 119-21 changed the rules for stock acquired after July 4, 2025. Qualifying stock can receive a 50% exclusion after three years, 75% after four years, and 100% after five years. For stock acquired after enactment, the dollar limitation for each issuer increased from $10 million to $15 million, subject to an alternative based on 10 times the shareholder's basis. For stock issued after July 4, 2025, the corporation's aggregate gross asset ceiling increased from $50 million to $75 million. The statute provides inflation adjustments after 2026.

QSBS treatment depends on facts that can change while the company operates. Redemptions, stock issuance, business activities, asset levels, holding periods, and the manner of acquisition can affect eligibility. You should evaluate Section 1202 before formation, before issuing stock, and before a financing or sale changes the relevant facts.

Qualified Business Income Deduction

Owners of sole proprietorships, partnerships, S corporations, and some trusts and estates may qualify for the Section 199A qualified business income deduction. The deduction can equal up to 20% of qualified business income, subject to taxable income thresholds, wage and property limits, specified service business rules, and other restrictions. Public Law 119-21 made the deduction permanent.

Section 199A excludes C corporation income and employee wages from qualified business income. You should calculate the deduction using your expected income, wages, property, business activity, and filing status instead of assuming that every owner of a qualifying entity receives the full 20%.

Texas Formation and Franchise Tax

The filing fee is $300 for a Texas LLC certificate of formation or corporate certificate of formation. Each entity must designate a consenting registered agent and maintain a registered office at a physical Texas street address where process can be served during business hours.

Texas franchise tax applies to both entity types unless an exemption or exclusion applies. For 2026 reports, an entity with annualized total revenue of $2.65 million or less generally files a Public Information Report or Ownership Information Report without a franchise tax report. Form 05-163, the No Tax Due Report, was discontinued beginning with reports due in 2024. Different rules apply to combined groups, passive entities, and entities that qualify for another exemption.

When an LLC Fits

An LLC often fits a closely held operating business, family business, real estate venture, or joint venture whose owners want taxation at the owner level and flexible economic terms. It also permits a subsequent S corporation election without changing the Texas entity form if the owners and ownership terms satisfy the federal requirements.

You should pay particular attention to transfer restrictions, management authority, deadlock procedures, capital calls, tax distributions, buyout rights, and allocations among members. Partnership tax treatment can accommodate economic arrangements that would violate the S corporation requirement of one class of stock, although federal tax rules limit how allocations may be structured.

When a Corporation Fits

A C corporation often fits a company that plans to seek venture financing, issue several rounds of preferred stock, grant familiar employee equity awards, retain earnings for growth, or pursue QSBS treatment. A corporation can also elect S treatment when its ownership and stock rights satisfy the federal restrictions.

You should examine the expected investor base before choosing S corporation treatment. A planned investment by a partnership, corporation, nonresident alien, or other ineligible shareholder can prevent or terminate the election, and preferred economic rights can create a prohibited second class of stock.

Conversion and Tax Elections

Texas law permits conversions between entity forms, and federal tax law assigns deemed transactions to some classification changes. When an LLC taxed as a partnership elects corporate treatment, federal law generally treats the partnership as contributing its assets and liabilities to a corporation for stock and then distributing that stock to its partners. A disregarded LLC's owner is generally treated as contributing the LLC's assets and liabilities for stock.

Section 351 generally provides nonrecognition when the transferors satisfy its requirements, including the control test immediately after the exchange. Liabilities exceeding tax basis, investment company rules, services, prearranged transfers, and other facts can change that result.

A corporation that converts to an LLC taxed as a partnership or disregarded entity generally faces a deemed corporate liquidation for federal tax purposes. That treatment can produce tax at the corporate and shareholder levels for a C corporation, and an S corporation can also create gain recognized by its shareholders or other consequences. Asset value, tax basis, liabilities, prior C corporation history, and the LLC's intended classification determine the result.

You should choose the entity with the next financing, ownership change, compensation plan, and exit in mind. A state filing can be inexpensive while the related tax consequences cost far more. Coordinating the certificate of formation, governing documents, tax election, equity documents, and owner agreements at formation protects the structure you intended to build.