US C-Corp vs S-Corp vs LLC: Tax and Liability Comparison

The three most common US business entities — C-Corporation, S-Corporation, and Limited Liability Company (LLC) — share one feature (limited liability) but diverge sharply on taxation, ownership rules, and growth optionality. This deep-dive compares them under the Internal Revenue Code (Subchapters C and S, IRC §§11, 1361, 1362) and standard state corporate / LLC statutes.

1. Liability Shield — Same in All Three

All three entities provide limited liability for their owners under the relevant state statute:

• C-Corp / S-Corp — shareholders not liable for corporate debts beyond invested capital (e.g., DGCL §102, MBCA §6.22).
• LLC — members not liable for LLC debts (e.g., 6 Del.C. §18-303, Wyo. Stat. §17-29-303).

The shield is pierced in all three only by extraordinary circumstances (commingling, undercapitalization, fraud). Choice of entity does not, by itself, make the shield stronger or weaker.

2. Federal Tax Treatment — Sharp Differences

The “double taxation” of C-Corps: Profits taxed at the entity level (21%), then dividend distributions taxed again on shareholders. Top combined federal rate: ~21% + 23.8% (qualified dividend + Net Investment Income Tax) = ~39.8% on distributed profits.

Pass-through avoids the entity-level tax. S-Corps and LLCs (default) pass income directly to owners, who pay personal income tax once.

3. Self-Employment Tax — The S-Corp Advantage

Under IRC §1402, a sole-proprietor LLC owner pays 15.3% self-employment tax (FICA) on all net earnings from self-employment, capped only by the Social Security wage base for the SS portion.

An S-Corp owner-employee pays FICA only on their W-2 wages. Distributions of remaining profit (K-1 income) are not subject to SE tax — this is the S-Corp’s signature tax advantage.

Example: Solo consultant earning USD 150,000.

IRS reasonableness requirement: Under IRC §1366(d) and IRS audit guidance, S-Corp owner-employee wages must be “reasonable compensation” for services rendered. Setting an artificially low salary to maximise distributions invites audit and reclassification. Use industry comparables (Glassdoor, BLS data).

4. Ownership Rules — S-Corp Is Restrictive

Under IRC §1361(b), an S-Corp must satisfy:

• ≤100 shareholders (married couples count as one);
• All shareholders must be US citizens or US-resident individuals — no non-resident aliens;
• Only certain types of entities as shareholders (estates, certain trusts, qualified retirement plans, certain charities);
• Only one class of stock (voting differences allowed; economic preferences not);
• A US domestic entity.

For foreign founders: S-Corp election is unavailable if any shareholder is a non-resident alien. C-Corps and LLCs have no such restriction.

5. Multiple Stock Classes — C-Corp Wins

Why VCs require C-Corp: Venture capital deals always involve preferred stock with liquidation preferences, conversion rights, anti-dilution protection, and dividend preferences. Only C-Corps support this complexity natively. S-Corps cannot have preferred stock; LLCs theoretically can have multiple member classes but VCs find LLC structures unwieldy.

6. Loss Pass-Through

For unprofitable startups burning capital, S-Corp and LLC pass-through let owners deduct losses against other income, lowering personal tax bills. C-Corp losses sit at the entity until profitability — useless to founders’ personal taxes.

7. QSBS — C-Corp’s Hidden Advantage

Under IRC §1202 (Qualified Small Business Stock):

• C-Corp shareholders holding stock for 5+ years in a “qualified small business” may exclude up to USD 10 million (or 10x basis, whichever greater) per shareholder from federal capital gains tax on sale.

QSBS is C-Corp only — not available to LLCs or S-Corps. For founders contemplating a 5+ year hold and exit, this can be a USD 2.4M+ tax savings (federal long-term capital gains otherwise 23.8%).

This is one of the strongest reasons VC-bound founders incorporate as C-Corp from day 1.

8. State Filing and Maintenance

LLCs typically have lighter governance requirements (no required board meetings, no required minutes for state purposes) than corporations.

9. Conversion Among Entities

Most founders form initially as LLC for simplicity, then convert to C-Corp before the first VC round. Conversion is straightforward but timing matters for QSBS holding period (the 5-year clock restarts on the C-Corp formation date).

10. Decision Framework

Choose LLC (default pass-through) if:

• Real estate holding company.
• Solo consulting business under USD 80K profit.
• Online business with one or two owners.
• Want simplicity, low maintenance, pass-through.

Choose LLC + S-Corp election if:

• Solo operating business consistently profitable (USD 80K+ net).
• Owner is US citizen / resident.
• Willing to run payroll and pay reasonable W-2 wages.

Choose S-Corp (direct) if:

• All owners US persons.
• Single class of stock acceptable.
• Looking for pass-through with W-2 wage flexibility.

Choose C-Corp if:

• Planning VC fundraising.
• ESOP / employee stock options.
• Foreign founders or institutional investors.
• 5+ year exit horizon (QSBS under IRC §1202).
• IPO path.

11. Common Errors

12. Quick Reference Table

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Sources

• Internal Revenue Code §11 (corporate tax) — https://www.law.cornell.edu/uscode/text/26/11
• IRC §1361 (S-Corp eligibility) — https://www.law.cornell.edu/uscode/text/26/1361
• IRC §1362 (S-Corp election) — https://www.law.cornell.edu/uscode/text/26/1362
• IRC §1202 (Qualified Small Business Stock) — https://www.law.cornell.edu/uscode/text/26/1202
• IRS Form 2553 (S-Corp election) — https://www.irs.gov/forms-pubs/about-form-2553
• IRS Form 8832 (entity classification election) — https://www.irs.gov/forms-pubs/about-form-8832