By Harry Prabandham · Updated September 28, 2026
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Choosing a Business Entity: LLC, S Corp, or C Corp
Entity choice sets how business income is taxed and how owners are shielded from liability. LLCs, S corps, and C corps trade flexibility, tax, and cost.
Choosing a Business Entity: LLC, S Corp, or C Corp
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How does entity choice affect a business owner?
- It decides whether profit is taxed once on the owners' returns or twice, at the company and again when paid as dividends.
- It also affects liability protection, payroll taxes, QSBS eligibility, and what outside investors will accept.
- A sole proprietorship needs no state filing but gives no liability shield and subjects all profit to self-employment tax.
- Changing structure later is possible but can trigger tax, so the first choice matters.
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How does entity choice affect a business owner?
- It decides whether profit is taxed once on the owners' returns or twice, at the company and again when paid as dividends.
- It also affects liability protection, payroll taxes, QSBS eligibility, and what outside investors will accept.
- A sole proprietorship needs no state filing but gives no liability shield and subjects all profit to self-employment tax.
- Changing structure later is possible but can trigger tax, so the first choice matters.
How is an LLC taxed?
- An LLC is formed under state law and gives its owners limited liability.
- By default, a single-member LLC is disregarded for income tax and a multi-member LLC is taxed as a partnership.
- An LLC can elect to be taxed as a corporation, including as an S corporation, without changing its legal form.
- California LLCs pay an $800 annual tax plus a separate fee once California income exceeds $250,000.
How does an S corporation work?
- Income passes through to shareholders, generally avoiding federal corporate income tax.
- Shareholder-employees must be paid reasonable compensation subject to payroll taxes; remaining profit can be distributed without Social Security or Medicare tax.
- Limits include no more than 100 shareholders, one class of stock, and generally only U.S. individuals, estates, and certain trusts as shareholders.
- California taxes S corporations at 1.5% of net income, with an $800 minimum franchise tax.
How does a C corporation work?
- A C corporation pays a flat 21% federal income tax, and dividends are taxed again to shareholders.
- It allows multiple share classes and unlimited shareholders, which venture investors typically require.
- Only C-corporation stock can qualify for the Section 1202 QSBS gain exclusion.
- California's corporate tax rate is 8.84%, with an $800 minimum franchise tax.
How do self-employment tax and the QBI deduction factor in?
- Self-employment tax is 15.3% on net earnings up to the 2026 Social Security wage base of $184,500, and 2.9% Medicare tax above it.
- The Section 199A deduction of up to 20% of qualified business income was made permanent by the July 2025 tax law; C-corporation income doesn't qualify.
- For 2026, wage and service-business limits phase in above $201,750 of taxable income ($403,500 joint) and fully apply at $276,750 ($553,500 joint).
- Starting in 2026, a minimum $400 deduction applies for eligible taxpayers with at least $1,000 of qualified business income.
When do owners revisit their structure?
- When profit grows enough that S-corporation payroll-tax savings may exceed the extra payroll, accounting, and state costs.
- When raising venture capital or aiming for QSBS treatment, which generally requires a C corporation.
- Before a sale, since entity type and asset-versus-stock deal structure change the tax result.
- A CPA and business attorney can model the trade-offs; Rubric doesn't prepare tax returns or give legal advice.
Key takeaways
- LLCs offer flexibility, S corporations can reduce payroll tax, and C corporations suit venture funding and QSBS.
- California adds its own minimum taxes and fees on top of federal rules.
- The 20% QBI deduction is now permanent, with 2026 limits starting at $201,750 single and $403,500 joint.
- Revisit the choice as profit, funding plans, and exit plans change.
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Self-employment tax is 15.3% Social Security and Medicare on 92.35% of net self-employment earnings; in 2026 the 12.4% part stops at $184,500.
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QSBS can exclude federal gain on qualifying startup stock: up to $15M or 10x basis for stock issued after July 4, 2025. California still taxes it.