LLC or Corporation: How to Choose the Right Entity for Your Business

By Hank FasthoffJuly 5, 2026

Every business needs a legal structure, and the choice between a limited liability company and a corporation is the first decision most founders face. Both provide limited liability protection, meaning the owner's personal assets are shielded from business debts and obligations. Beyond that shared feature, LLCs and corporations differ in how they're taxed, how they're governed, how they raise capital, and how they compensate key employees. Getting the structure right at formation saves money and complexity. Getting it wrong creates problems that compound as the business grows.

How LLCs Are Taxed

An LLC is a state-law entity that doesn't have its own federal tax classification. By default, a single-member LLC is treated as a disregarded entity (taxed on the owner's personal return), and a multi-member LLC is treated as a partnership (filing Form 1065 and issuing K-1s to members). In both cases, income passes through to the owners and is taxed once, at their individual rates.

LLC members who are active in the business pay self-employment tax (Social Security and Medicare) on their share of business profits. For 2026, the self-employment tax rate is 15.3 percent on the first $176,100 of net self-employment income (the Social Security wage base, adjusted annually) plus 2.9 percent Medicare tax on earnings above that threshold. For an LLC generating $200,000 in profit, the self-employment tax alone can exceed $25,000.

An LLC can elect to be taxed as an S corporation by filing IRS Form 2553. Under S corp taxation, the owner pays self-employment tax only on a "reasonable salary" and takes remaining profits as distributions that aren't subject to self-employment tax. If the LLC generates $200,000 in profit and the owner takes a reasonable salary of $90,000, self-employment tax applies only to the $90,000, and the remaining $110,000 passes through as a distribution. At higher profit levels, the annual savings can reach $10,000 to $15,000 or more. Most CPAs recommend the S corp election once an LLC consistently generates $60,000 to $80,000 in annual net income, because below that threshold the payroll compliance costs often exceed the tax savings.

An LLC can also elect C corporation taxation by filing IRS Form 8832, though this is less common and carries the double-taxation consequences described below.

How Corporations Are Taxed

A C corporation is a separate taxpaying entity. It pays federal income tax at a flat 21 percent rate on its taxable income. When the corporation distributes after-tax profits to shareholders as dividends, the shareholders pay tax again on those dividends at their individual rates (qualified dividends are taxed at 0, 15, or 20 percent depending on the shareholder's income). This is double taxation, and it's the feature that makes C corporations less attractive for businesses that regularly distribute profits to their owners.

For businesses that reinvest most of their earnings rather than distributing them, the 21 percent corporate rate can be lower than the owner's individual rate (which can reach 37 percent at the top federal bracket). A founder in the 37 percent bracket who reinvests all profits saves 16 cents on every dollar of income by operating through a C corporation instead of a pass-through entity, as long as the money remains in the corporation.

An S corporation avoids double taxation. Like an LLC taxed as a partnership, an S corporation passes income through to shareholders and is taxed once at their individual rates. But S corporations face restrictions that LLCs don't. An S corporation can't have more than 100 shareholders, can't have foreign shareholders, can't have shareholders that are corporations or partnerships (with limited exceptions), and can't issue more than one class of stock. Any of these restrictions can disqualify the S election, and violating one retroactively converts the entity to C corporation status.

Why Investors Require C Corporations

Venture capital firms, angel investors, and institutional investors almost universally require portfolio companies to be C corporations. There are several reasons, and none of them are negotiable.

C corporations can issue preferred stock with liquidation preferences, anti-dilution protections, board seats, and other terms that investors require. An LLC can replicate some of these economics through its operating agreement, but the documentation is nonstandard, investors' lawyers aren't familiar with it, and the negotiation takes longer and costs more.

C corporations can issue stock options and restricted stock units to employees through equity incentive plans that follow well-established tax and securities law frameworks (including Section 409A valuations and the incentive stock option rules under Section 422). LLCs can issue profits interests, which serve a similar function, but the tax treatment is different, the documentation is less familiar to employees, and many prospective hires won't understand what they're receiving.

C corporations qualify for the Qualified Small Business Stock (QSBS) exclusion under Section 1202 of the Internal Revenue Code, which can exclude up to $10 million (or 10 times the shareholder's basis) in capital gains from federal tax when C corporation stock is sold after a five-year holding period. Under the One Big Beautiful Bill Act (signed July 4, 2025), the QSBS rules were modified for stock acquired after July 4, 2025, with tiered exclusions (50 percent after three years, 75 percent after four years, 100 percent after five years) and an increased gross asset threshold of $75 million. For founders planning an exit, the QSBS exclusion can save millions in federal tax. It isn't available to LLCs or S corporations.

If you're planning to raise institutional capital, issue equity compensation to employees, or pursue an exit through acquisition or IPO, form a C corporation (typically in Delaware) from the start. Converting an LLC to a C corporation later is possible but creates transaction costs, potential tax consequences, and delays that could have been avoided.

How Governance Differs

LLCs are governed by an operating agreement (called a company agreement in Texas). The operating agreement can be as simple or as detailed as the members want. LLCs can be member-managed (all members participate in management) or manager-managed (designated managers run the business, similar to a board of directors). Texas doesn't require LLCs to hold annual meetings, adopt bylaws, or maintain minutes, though doing so is good practice.

Corporations are governed by bylaws, a board of directors, and officers. Texas requires corporations to hold an annual meeting of shareholders, maintain corporate records, and observe formalities that distinguish the corporation from its owners. Failure to observe corporate formalities can support a claim to "pierce the corporate veil," which eliminates the liability protection the entity was formed to provide.

For a solo founder or a small team that wants minimal administrative overhead, an LLC's flexibility is an advantage. For a company with outside investors, a board of directors, and employees receiving equity compensation, a corporation's board-and-bylaws governance is expected and appropriate.

The Qualified Business Income Deduction

Pass-through entities (LLCs, S corporations, partnerships, and sole proprietorships) may qualify for the Qualified Business Income (QBI) deduction under Section 199A, which allows eligible owners to deduct up to 20 percent of qualified business income from their taxable income. Congress made the QBI deduction permanent through the One Big Beautiful Bill Act in 2025, removing the sunset scheduled for the end of 2025.

C corporations don't qualify for the QBI deduction because their income isn't passed through to owners. For some business owners, the 20 percent QBI deduction makes pass-through taxation more attractive than the 21 percent corporate rate, depending on income level, industry, and how much the owner pays in wages.

QBI deduction eligibility is subject to limitations for specified service trades or businesses (SSTBs), which include law, accounting, health care, consulting, financial services, and other professional services. Above certain income thresholds, the deduction phases out for SSTBs. Whether the QBI deduction affects your entity choice depends on your industry, your income level, and your marginal tax rate, and it's a calculation you should run with a CPA before making the decision.

Texas Formation Basics

Forming an LLC in Texas requires filing a certificate of formation with the Texas Secretary of State (filing fee of $300) and designating a registered agent with a physical address in Texas. Forming a corporation requires filing a certificate of formation (filing fee of $300) and designating a registered agent. Both entity types must file an annual franchise tax report with the Texas Comptroller, even if no tax is owed.

Texas doesn't impose a state income tax on individuals, but it does impose a franchise tax (sometimes called a margin tax) on entities. The franchise tax applies to entities with annualized total revenue exceeding $2.47 million (for 2025 reports; the threshold adjusts annually). Entities below that threshold file a no-tax-due report but still must file.

When to Choose an LLC

An LLC is the right choice for most small businesses, service businesses, real estate holdings, and companies that don't plan to raise institutional capital. It provides liability protection, pass-through taxation, operational flexibility, and lower compliance overhead than a corporation. If the business becomes profitable enough to justify it, the LLC can elect S corporation tax treatment without changing its state-law structure.

When to Choose a Corporation

A corporation is the right choice when the business plans to raise venture capital or institutional investment, when it needs to issue stock options or RSUs to attract employees, when the founder wants to take advantage of the QSBS exclusion on a future exit, or when the business needs multiple classes of stock to accommodate investors with different economic and governance rights. If any of those factors apply, form a C corporation from the start rather than forming an LLC and converting later.

The Decision Isn't Permanent, but Changing It Is Expensive

An LLC can convert to a corporation, and a corporation can convert to an LLC. But every conversion has tax consequences, legal costs, and administrative complexity. Converting an LLC to a C corporation may trigger a taxable event for the members. Converting a C corporation to an LLC triggers a deemed liquidation that can generate significant tax liability. An S corporation that violates any of its eligibility requirements (too many shareholders, a foreign shareholder, a second class of stock) loses its S election retroactively and becomes a C corporation, potentially creating unexpected tax liability for all shareholders.

Choose the right entity at formation and you avoid conversion costs, tax surprises, and the disruption of restructuring while the business is operating. If you're unsure which structure fits, the analysis is worth doing before you file, not after.