The short answer
There is no single best entity. A C corporation pays a flat 21% federal rate and can issue qualified small business stock; an S corporation or LLC passes income through to the owners, who may qualify for the 20% qualified business income deduction, now permanent. The right choice depends on how profits are used, who owns the company and whether a sale or capital raise is likely.
The three options in plain terms
LLC. A legal entity that, by default, is taxed as a partnership if it has more than one owner or ignored for tax if it has one. It can elect to be taxed as an S or C corporation.
S corporation. A tax election. Income passes through to shareholders. The IRS limits S corporations to 100 shareholders, generally individuals who are U.S. citizens or residents, and one class of stock.
C corporation. Pays its own federal income tax at a flat 21% under 26 U.S.C. § 11. Profits paid out as dividends are taxed again to the shareholder.
What changed in 2025 that still matters in 2026
- The 20% QBI deduction is permanent. The One, Big, Beautiful Bill Act removed the deduction’s scheduled expiration, so owners of pass-through businesses can keep planning around it, subject to income thresholds and limits for service businesses.
- QSBS got bigger. For C corporation stock issued after July 4, 2025, the Section 1202 exclusion now phases in at 50% after three years, 75% after four and 100% after five. The per-issuer cap rose to the greater of $15 million or 10 times basis, and the company’s gross-asset limit rose to $75 million.
- Full expensing of equipment returned. 100% bonus depreciation was restored for qualifying property acquired after January 19, 2025.
How owners usually think about the choice
- Where profits go. If most profit is distributed to owners each year, pass-through treatment often avoids a second layer of tax. If profit stays in the company to fund growth, the 21% rate can matter more.
- Who the investors are. Venture and institutional investors generally expect a C corporation. S corporation ownership limits can block a raise.
- The exit. A planned sale in five or more years may make QSBS worth modeling, but only for a qualified trade or business. Many service fields, including law, accounting, health and consulting, do not qualify.
- State tax. States treat entities differently, so the federal answer is only part of it.
Changing entities later
Conversions are possible but not free. Converting an S corporation or LLC to a C corporation can start the QSBS clock, and converting a C corporation to an S corporation can trigger built-in gains rules. Model the change before the year it takes effect.
Entity comparison at a glance (federal)
| LLC (default) | S corporation | C corporation | |
|---|---|---|---|
| Who pays income tax | Owners | Shareholders | The company, then shareholders on dividends |
| Federal rate | Owner’s individual rate | Shareholder’s individual rate | Flat 21% |
| QBI deduction | May qualify | May qualify | No |
| QSBS (§ 1202) | No | No | May qualify |
| Ownership limits | Flexible | 100 shareholders, one class of stock | Flexible |
Questions owners ask
Is an S corporation always better for a profitable small business?
No. It often helps owners who take reasonable salaries and distribute the rest, but ownership limits, state taxes and plans to raise capital or sell can point the other way.
What is QSBS?
Qualified small business stock under Section 1202 of the tax code. Gain on qualifying C corporation stock can be partly or fully excluded from federal tax if holding-period, gross-asset and active-business rules are met. For stock issued after July 4, 2025, the cap is the greater of $15 million or 10 times basis.
Can an LLC be taxed as a C corporation?
Yes. An LLC can elect to be taxed as a corporation, and then elect S status if it qualifies. The legal entity and the tax treatment are separate decisions.
Sources
- 26 U.S.C. § 11: Corporate tax rate
- IRS: S corporations
- IRS: Qualified business income deduction
- IRS: One, Big, Beautiful Bill provisions
- 26 U.S.C. § 1202: Qualified small business stock
This guide is general information, not legal, tax or investment advice for your situation, and it may not reflect changes in the law after the date above. Talk to a qualified professional before acting on it.
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