LLC vs. S-Corp vs. C-Corp: Choosing the Right Business Entity

The three main entity structures each serve different purposes. Here's how they compare on the factors that matter most. The IRS's official business structures guide is the authoritative reference for federal tax treatment of each entity type, and the Small Business Administration's entity comparison provides a plain-language overview.

Limited Liability Company (LLC). An LLC is the most popular entity for small businesses. It provides personal liability protection -- your personal assets (home, savings, car) are generally shielded from business debts and lawsuits. By default, a single-member LLC is taxed as a sole proprietorship (pass-through), and a multi-member LLC is taxed as a partnership. You report business income on your personal return and pay self-employment tax on all net profits. LLCs are flexible, inexpensive to maintain, and require minimal formalities. The downside: you can't issue stock, which complicates fundraising.

S-Corporation. An S-Corp is not a separate entity type -- it's a tax election that can be applied to an LLC or a corporation by filing IRS Form 2553. The key benefit: you can split business income into a reasonable salary (subject to payroll taxes) and distributions (not subject to self-employment tax). On $100,000 in net profit, paying yourself a $60,000 salary and taking $40,000 in distributions saves roughly $6,120 in self-employment tax. The trade-offs: you must run payroll, file a separate corporate tax return (Form 1120-S), and comply with strict ownership rules (100 shareholders max, U.S. citizens/residents only, one class of stock).

C-Corporation. A C-Corp is a fully separate legal entity with its own tax identity. It pays corporate income tax at 21% on profits. When those profits are distributed to shareholders as dividends, the shareholders pay tax again -- this is double taxation. Despite this disadvantage, C-Corps are essential for businesses raising venture capital. Investors expect to purchase preferred stock with specific rights, and only corporations can issue different classes of stock. C-Corps also offer the Section 1202 qualified small business stock exclusion, which can eliminate up to $10 million in capital gains tax on exit. The business formation copilot can walk you through the full comparison in the context of your specific business. See our LLC vs. sole proprietorship comparison guide if you are still deciding whether to form any entity at all, and explore side hustle tax obligations for what you owe before you incorporate.

Tax treatment is usually the deciding factor. Let's work through concrete examples at different income levels. All figures are based on the IRS's 2025 tax year inflation adjustments and the current 21% corporate tax rate established by the Tax Cuts and Jobs Act.

At $30,000 net profit: An LLC (sole proprietorship) owes roughly $4,590 in self-employment tax plus $1,800-$3,400 in income tax, depending on your total tax situation. An S-Corp at this level doesn't make sense -- the payroll costs ($500-$2,000/year) and additional tax prep fees ($500-$1,500) would eat the SE tax savings. A C-Corp would pay $6,300 in corporate tax (21%), and you'd pay additional personal tax on any salary or dividends. At this level, a simple LLC wins.

At $80,000 net profit: An LLC owes roughly $12,240 in self-employment tax. An S-Corp with a $50,000 reasonable salary and $30,000 in distributions saves approximately $4,590 in SE tax. After subtracting $1,500-$3,000 in additional payroll and tax prep costs, the net savings is roughly $1,500-$3,000. The S-Corp starts to pull ahead. The tax copilot can calculate the exact crossover point for your situation.

At $200,000+ net profit: The S-Corp advantage grows significantly. With a $90,000 reasonable salary and $110,000 in distributions, you save roughly $16,830 in SE tax versus a straight LLC. Even after additional costs, the savings is substantial. However, if you're raising investment, a C-Corp may be necessary regardless of the tax math.

The C-Corp tax trap to watch for: Many founders form C-Corps assuming they'll reinvest all profits and avoid dividends. This works as long as the company is growing. But when you eventually want to take money out, you face double taxation unless you sell the company (potentially qualifying for the Section 1202 exclusion) or dissolve it. Accumulated earnings over $250,000 can also trigger an additional accumulated earnings tax of 20%. The business finance copilot can model how retained earnings strategies interact with C-Corp taxation. For broader context, see how Copilotly helps entrepreneurs across formation, taxes, and growth decisions, or explore the side hustle taxes scenario if your business is still early stage.

The formation process is simpler than most people expect. Here's what you actually need to do, step by step.

Step 1: Choose your entity name. Search your state's business entity database to confirm the name is available. Most states allow you to search online for free. Your entity name must be distinguishable from existing registrations. For LLCs, the name typically must include 'LLC' or 'Limited Liability Company.' For corporations, it must include 'Inc.,' 'Corp.,' or 'Corporation.' Note that a state name registration is different from a trademark -- you can have the same business name as a company in another state.

Step 2: Designate a registered agent. Every entity needs a registered agent with a physical address (not a P.O. box) in the state of formation. The registered agent receives legal documents, tax notices, and compliance communications. You can be your own registered agent if you have an address in the state, or you can hire a service for $50-$300 per year. Services like Northwest Registered Agent, Incfile, or CSC are commonly used.

Step 3: File formation documents. For an LLC, file Articles of Organization. For a corporation, file Articles of Incorporation (Certificate of Incorporation in Delaware). Most states accept online filing and process within 1-5 business days. Expedited processing is available for an additional fee. The filing typically requires: entity name, registered agent information, organizer/incorporator name, principal office address, and the entity's purpose (a general statement like 'any lawful purpose' works in most states).

Step 4: Get your EIN. Apply online at irs.gov. It's free and you receive the number immediately. You need this for business banking, tax filing, and hiring. The business formation copilot can walk you through each of these steps for your specific state and entity type.

Step 5: Draft internal governance documents. For an LLC, this is an Operating Agreement. For a corporation, these are Bylaws and potentially a Shareholder Agreement. These documents are critically important -- they define who owns what, how decisions are made, how profits are distributed, and what happens when someone wants to leave. Even single-member LLCs should have an operating agreement. The legal copilot can help you draft these documents with provisions tailored to your situation.

Your internal governance documents are arguably more important than your state filing. They define the rules that govern your business relationships. Skipping them is one of the most common and costly mistakes founders make.

For LLCs: The Operating Agreement. This document covers: member ownership percentages, capital contributions, profit and loss allocation, management structure (member-managed vs. manager-managed), voting rights, how new members are admitted, how members can exit or transfer interests, what happens if a member dies or becomes incapacitated, and dissolution procedures. In many states, the operating agreement supersedes default state law, so you have significant flexibility to customize. Without one, your state's default LLC act fills in the blanks -- and those defaults may not match your intentions.

For Corporations: Bylaws and Shareholder Agreements. Bylaws govern the corporation's internal operations: board of directors composition, officer roles, meeting requirements, quorum rules, and amendment procedures. A shareholder agreement goes further, covering stock transfer restrictions, right of first refusal, tag-along and drag-along rights, and buy-sell provisions. If you have co-founders, this is where you define vesting schedules (the standard is 4-year vesting with a 1-year cliff, meaning founders earn their shares over time).

Vesting schedules for co-founders. This is critical and often overlooked. If two founders split a company 50/50 and one leaves after three months, does the departing founder keep 50% of the company? Without a vesting schedule, yes. A standard 4-year vesting schedule with a 1-year cliff means no shares vest in the first year, then 25% vest at the one-year mark, and the remainder vest monthly over the next 36 months. This protects both founders and is expected by investors. The startup copilot can help you structure founder equity with appropriate vesting provisions.

Intellectual property assignment. Every founder should sign an IP assignment agreement transferring any business-related intellectual property to the company. Without this, a departing founder could argue they own the code, designs, or inventions they created. This is especially important for C-Corps seeking investment -- investors will conduct due diligence and this is one of the first things they check.

Many businesses start with one entity type and convert to another as their needs evolve. Understanding when to convert can save you significant money and headaches.

LLC to S-Corp (tax election). This is the most common conversion. When your net LLC income consistently exceeds $40,000-$50,000, the self-employment tax savings from S-Corp election usually outweigh the added administrative costs. File Form 2553 with the IRS by March 15 (for the current year) or within 75 days of formation. Note that you can elect S-Corp treatment for your LLC without changing anything at the state level -- your LLC remains an LLC, but the IRS treats it as an S-Corp for tax purposes.

LLC to C-Corp (entity conversion). If you're raising venture capital, you'll likely need to convert to a C-Corp. This involves either forming a new C-Corp and merging the LLC into it, or using a statutory conversion process (available in many states). The conversion has tax consequences -- the IRS treats it as though the LLC distributed its assets to members, who then contributed them to the new corporation. This can trigger taxable gain if the LLC has appreciated assets. Do this with professional guidance. The tax copilot can help you understand the tax implications before you commit.

S-Corp to C-Corp. This happens when S-Corp restrictions become limiting (e.g., you need foreign shareholders or multiple stock classes for investors). Revoking S-Corp status is straightforward: file a revocation statement with the IRS. However, there's a 5-year waiting period before you can re-elect S-Corp status, and the transition creates a 'short tax year' with additional filing requirements.

When not to convert. If your business is stable, profitable, and you're not raising external investment, there's rarely a reason to switch from an LLC or S-Corp to a C-Corp. The double taxation issue is real. Similarly, if your income is under $40,000 net, converting to an S-Corp adds complexity without meaningful tax savings. The business finance copilot can model whether the economics of conversion make sense for your specific numbers.

Forming your entity is just the beginning. Every entity type has annual compliance requirements that you cannot ignore without consequences.

Annual state reports. Most states require LLCs and corporations to file an annual report (sometimes called a biennial report or statement of information). This updates your registered agent, principal office address, and officer/manager information. Fees range from $0 (some states) to $800+ (California's franchise tax for LLCs). Missing this deadline can result in your entity being administratively dissolved, which strips your liability protection retroactively.

Franchise taxes. Some states charge a franchise tax for the privilege of existing as a business entity. Delaware's franchise tax is $300/year for LLCs and starts at $400/year for corporations (but can be much higher based on share structure). California charges an $800 minimum franchise tax for both LLCs and corporations, even if the business had no income. This catches many founders off guard in year one.

Tax returns. Sole proprietorships and single-member LLCs file Schedule C with Form 1040 (due April 15). S-Corps file Form 1120-S (due March 15). C-Corps file Form 1120 (due April 15). Partnerships and multi-member LLCs file Form 1065 (due March 15). S-Corp and partnership returns are informational -- the tax passes through to the owners' personal returns via K-1 forms. C-Corp returns are standalone because the corporation is a separate taxpayer.

Payroll compliance (S-Corps and C-Corps with employees). If you have employees or pay yourself a salary (required for S-Corps), you must withhold federal and state income taxes, Social Security, and Medicare. File Form 941 quarterly. File Form 940 annually for unemployment tax. Issue W-2s by January 31. Many businesses use payroll services like Gusto or ADP to handle this, typically costing $40-$100/month plus $6-$12 per employee per month.

The bookkeeping copilot can build you a complete compliance calendar with every deadline, filing requirement, and estimated cost for your specific entity type and state, so nothing slips through the cracks.