Choosing the Right Business Entity: C Corp, S Corp, or LLC?

Choosing your business entity is one of the most important decisions you’ll make. It affects your taxes, liability protection, ability to raise capital, and future flexibility. But making the right choice can be difficult. Read our guide to learn everything you need to know to ensure you are choosing the right business entity.

When it comes to making the right choice about your business structure, you are likely going to be selecting between three types: a C Corp, an S Corp, and an LLC. Here is what to know about each to ensure you are choosing the right business entity.

C Corporation – Ideal for businesses seeking venture capital or planning to go public

C Corporations offer unlimited growth potential by allowing multiple classes of stock and an unlimited number of shareholders, making them the preferred choice for venture capitalists and institutional investors.

Founders and early investors may also qualify for Qualified Small Business Stock (QSBS) benefits, potentially excluding up to $15 million in capital gains from taxation.

C-Corps provide strong liability protection and can own other C-Corps, S-Corps, and LLCs, though owning an S-Corp terminates that entity’s S election. But C-Corps face double taxation, profits are taxed at the corporate level and again when distributed to shareholders as dividends.

They also require complex compliance, including board meetings, annual reports, and formal procedures, making them the most expensive entity type to maintain.

S Corporation – Ideal for profitable service businesses and small companies distributing profits to owners

S Corporations provide pass-through taxation, meaning income flows directly to shareholders without corporate-level tax, avoiding the double taxation of C-Corps.

The major advantage is self-employment tax savings: shareholders pay themselves a reasonable salary (subject to 15.3% self-employment tax) but can take additional profits as distributions that aren’t subject to this tax.

S-Corp shareholders also benefit from the 20% Qualified Business Income deduction.

The tradeoffs are significant. S-Corps are limited to 100 shareholders who must be U.S. citizens or residents, and only one class of stock is permitted. Distributions must be made in exact proportion to ownership percentages, eliminating flexibility in compensation arrangements.

Most importantly, S-Corps face severe ownership restrictions: they cannot be owned by C-Corps, partnerships, multi-member LLCs, or other S-Corps.

If an ineligible entity acquires S-Corp stock, the S election terminates automatically, potentially creating adverse tax consequences. This makes S-Corps unsuitable as holding companies in most multi-entity structures. The IRS also closely scrutinizes S-Corps to ensure compliance with reasonable compensation requirements.

Limited Liability Company (LLC) – Ideal for maximum flexibility and simple operations

LLCs are a legal structure, not a tax classification. This is the critical distinction.

By default, single-member LLCs are taxed as disregarded entities (like sole proprietorships) and multi-member LLCs are taxed as partnerships. However, LLCs can elect to be taxed as S-Corps or C-Corps, providing unmatched flexibility to optimize tax treatment as your business evolves.

When taxed as partnerships, LLCs offer tremendous flexibility in profit allocations through their operating agreements, unlike S-Corps, which must distribute in exact proportion to ownership.

LLCs have minimal compliance requirements, no mandatory board meetings or annual reports, making them simpler and less expensive to maintain than corporations.

They provide the same liability protection as corporations and can be owned by anyone: individuals, C-Corps, S-Corps (if single-member), other LLCs, partnerships, trusts, or foreign entities. LLCs also work well as holding companies since they can own multiple entities without the ownership restrictions that plague S-Corps.

The primary disadvantage of LLCs taxed as disregarded entities or partnerships is that members generally pay self-employment tax on all business income, not just salary. This can result in significantly higher taxes than an S-Corp structure.

Additionally, venture capitalists and institutional investors typically prefer C-Corps over LLCs for significant capital raises or IPOs. However, LLCs can elect S-Corp taxation to gain self-employment tax advantages or C-Corp taxation if seeking institutional investment, providing a path to optimize as circumstances change.

Ownership Restrictions: What Can Own What?

Understanding ownership restrictions is critical for planning corporate structures and avoiding costly mistakes.

C Corporations can be owned by anyone and can own anything, though purchasing an S-Corp terminates that entity’s S election. S Corporations can only be owned by individuals who are U.S. citizens or residents, certain trusts, and estates, not by other corporations or multi-member LLCs.

If an ineligible shareholder acquires S-Corp stock, the S election automatically terminates. S-Corps can own C-Corps and single-member LLCs, but generally cannot own other S-Corps, making them impractical as holding companies.

LLCs can be owned by anyone and can own anything, providing maximum flexibility for holding company structures.

This matters significantly in practice. If you’re building a holding company structure to own multiple operating businesses, C-Corps and LLCs provide the necessary flexibility, while S-Corps cannot effectively serve this role.

Similarly, if you plan to be acquired by another business, a C-Corp parent acquiring your S-Corp terminates the S election immediately, potentially creating unexpected tax consequences.

C-Corp vs. LLC for Holding Companies: Which Should You Choose?

Both C-Corps and LLCs can serve as effective holding companies, but the choice depends on your specific circumstances:

Choose a C-Corp holding company when: You plan to retain significant earnings at the holding company level rather than distributing them to owners. The corporate tax rate may be advantageous for accumulating capital for future acquisitions or investments. You’re building a structure that will eventually go public or attract institutional investors who prefer corporate structures. You need to offer different classes of stock to investors or key employees. You want to take advantage of certain tax strategies available only to C-Corps, such as tax-free reorganizations under Section 368.
Choose an LLC holding company when: You want pass-through taxation to avoid double taxation on profits distributed to owners. The holding company will primarily pass through income from operating subsidiaries without accumulating substantial earnings. You need maximum flexibility in allocating profits and losses among owners disproportionate to ownership percentages. You want simpler compliance and lower administrative costs—no board meetings or corporate formalities required. Your ownership group includes entities or individuals that couldn’t own S-Corp stock, but you still want pass-through treatment. You’re building a real estate holding structure where depreciation and other tax attributes flow through more beneficially.
Hybrid Approach: Many sophisticated structures use both, for example, an LLC holding company that owns multiple C-Corp operating companies, or a C-Corp parent that owns LLC subsidiaries. The optimal structure depends on your specific tax situation, exit strategy, and operational needs. This is where experienced legal and tax counsel becomes invaluable.

Quick Decision Guide for Choosing the Right Business Entity

To make this choice even easier, we have simplified what you should consider when making this decision. Here is our quick decision guide for choosing the right business entity:

Choose C-Corp if:

Raising venture capital
Planning to go public
Need complex ownership structures with different stock classes
Building a holding company that will retain and reinvest earnings
Want access to C-Corp-only tax strategies

Choose S-Corp (or LLC electing S-Corp taxation) if:

Profitable and want to minimize self-employment taxes
Keeping ownership simple (under 100 U.S. shareholders)
Distributing profits regularly
Don’t need a holding company structure

Choose LLC (partnership/disregarded taxation) if:

Want maximum flexibility
Need creative profit-sharing arrangements
Starting out and want to elect S-Corp or C-Corp taxation later
Simple operations with minimal compliance burden
Building a holding company with pass-through taxation and flexible distributions
Real estate holding structures

So, what’s the bottom line? The stakes are high. This decision can mean hundreds of thousands in tax savings or costly restructuring down the road. Petersen + Landis PC helps entrepreneurs navigate entity selection by modeling tax outcomes across different structures, understanding ownership restrictions, electing optimal tax treatment for LLCs, designing holding company structures, and planning for future growth and acquisitions.

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Disclaimer: For informational purposes only. Not legal or tax advice. Consult qualified advisors for your specific situation.