LLC or C Corporation: How to Choose for Tax

What is the main tax difference between an LLC and a C corporation?

An LLC is a state-law entity whose federal income tax treatment depends on its owners and elections. A C corporation is a separate taxpayer: its profit can be taxed once at the company and again when paid as a dividend to an owner (IRS: LLC classification; IRS: forming a corporation).

By default, a one-owner LLC is disregarded for federal income tax; a multiple-owner LLC is a partnership. In both cases, owners generally report the business's taxable results whether or not they withdraw cash. A C corporation instead reports its own income on Form 1120. Its federal tax rate is 21% (Internal Revenue Code, section 11).

How do LLC and C corporation taxes compare side by side?

The useful comparison is who reports profit, when owners need cash, and what happens to losses. The table assumes the LLC keeps its default federal classification; an election changes its column (IRS: LLC classification).

The owner's income tax rate, work in the business, payroll, state taxes, and any sale all affect the actual comparison. Working LLC owners may owe self-employment tax; corporate wages can trigger payroll taxes (IRS: LLC classification; IRS: forming a corporation). For filing details, see how LLCs are taxed and how C corporations are taxed.

When does a C corporation's double taxation cost more?

A C corporation's two tax layers are most likely to cost more when it regularly distributes profit as dividends, but the result depends on the owners' tax rates, payroll taxes, deductions and state tax. The corporation pays income tax first; the owner then reports the dividend. A default LLC generally passes profit through to its owners instead, so it has no corporate income tax layer (IRS: forming a corporation; IRS: dividends).

Keeping earnings in a C corporation can postpone the dividend layer. Retaining earnings for present or reasonably anticipated business needs does not by itself trigger the accumulated earnings tax. That tax may apply when earnings accumulate beyond those needs to avoid shareholder tax; a separate personal holding company tax can apply when the corporation meets its income and ownership tests (Internal Revenue Code, sections 532–533; section 537; section 542). A salary for work performed has different tax treatment from a dividend; see paying yourself.

Can an LLC be taxed as a C corporation?

Yes. An eligible LLC can file Form 8832 to elect corporate classification. It remains an LLC under state law but files and pays federal tax as a corporation; the election does not by itself turn membership interests into shares issued under state corporate law (IRS: Form 8832; IRS: LLC classification).

Form 8832 must be signed by all current owners or an authorized officer, manager or member; a former owner must also sign if the election is retroactive to when they owned the LLC. Its effective date can be no more than 75 days before filing or 12 months after. After a change election, another generally cannot take effect for 60 months (IRS: Form 8832 and instructions). See how LLCs are taxed for election details and changing your business structure if the LLC already holds assets.

What does the section 1202 stock-sale exclusion require?

Section 1202 can exclude qualifying gain when a noncorporate taxpayer sells or exchanges eligible stock in a domestic C corporation. It applies to a stock sale or exchange, subject to requirements throughout the holding period; it is not a general break on selling a business or its assets (Internal Revenue Code, section 1202).

For stock acquired after July 4, 2025, the exclusion is 50% after at least three years, 75% after at least four years, and 100% after at least five years. The per-issuer gain limit for that stock is generally the greater of $15,000,000 or ten times the owner's adjusted basis in the stock. Eligible gain taken into account under section 1202 in earlier years reduces the dollar limit; older-stock gain taken into account in the same year can also reduce the newer-stock limit. Stock acquired on or before that date keeps the older more-than-five-year holding rule and generally the $10,000,000 dollar limit or ten-times-basis alternative; the exclusion percentage for older stock depends on its acquisition date (Internal Revenue Code, section 1202).

A sale before the exclusion holding period may instead qualify for a section 1045 rollover: the seller must have held the stock more than six months, buy replacement qualifying stock within 60 days, and elect on the timely return, including extensions (IRS: Publication 550). A future sale is uncertain: the business must stay eligible, the owner must have qualifying gain from a stock sale or exchange, and state tax may still arise. California does not conform to the federal section 1202 exclusion (California FTB: federal changes). Keep incorporation documents, stock issuance records, contribution valuations, capitalization records and records showing how company assets were used.

Can an LLC, or an LLC taxed as a C corporation, qualify for section 1202?

Selling a default LLC membership interest is not a sale of C corporation stock under section 1202. A partnership-taxed LLC can, however, hold qualifying C corporation stock and pass eligible sale gain through to owners who held their LLC interests from the stock's acquisition through its sale. Each owner's eligible amount is capped by the interest held when the LLC acquired the stock (Internal Revenue Code, section 1202(g)).

A Form 8832 election does not establish that an LLC's membership interests are “stock” for section 1202. IRS Private Letter Ruling 201636003 concerned originally issued corporate stock sold after the business converted back to a corporation. It does not decide whether selling interests in an elected LLC qualifies and cannot be cited as precedent. Get transaction-specific advice before relying on the exclusion (Internal Revenue Code, section 1202(c); IRS: Form 8832).

How are early losses treated in each structure?

Early losses from a default LLC may reach the owner's return, but a loss is deductible only to the extent the owner's facts satisfy the applicable limits. A C corporation's operating losses stay with the corporation; shareholders cannot deduct them against their wages or other personal income (IRS: forming a corporation; IRS: excess business losses).

For limits on using an LLC loss against other income and on corporate loss carryovers, see business losses.

How do state taxes and annual fees differ?

State cost depends on where the business forms and operates, not just its federal classification. Formation fees, annual reports, income taxes, franchise taxes and LLC-specific fees can differ, including when a business forms in one state but operates in another (IRS: business structures).

California illustrates the difference: an LLC may owe an annual tax and income-based fee, while a corporation faces franchise tax and different first-year rules (California FTB: LLC; California FTB: corporations). See California's minimum tax and LLC fee and Delaware franchise tax for the state rules.

Where does an S corporation fit in?

An S corporation election is another federal tax path for an eligible corporation or LLC. Its income generally passes through to shareholders, but eligibility and payroll rules make it a separate choice; section 1202 requires C corporation stock during substantially all the holding period (IRS: S corporations; Internal Revenue Code, section 1202). See when an S corporation election pays off.

Example

Illustrative US dollars; assume the dividend tax stated below. This ignores state tax, payroll, loss limits and other owner taxes.

A business has $100,000 of taxable operating profit and its owner takes out $40,000. As a default one-owner LLC, the owner generally reports the $100,000 business profit for federal income tax even though only $40,000 was withdrawn. The withdrawal is ordinarily not another tax on that same profit.

If the business is instead a C corporation, it pays $21,000 of federal income tax on the $100,000, leaving $79,000. Assume it pays a $40,000 dividend and the owner's federal tax on that dividend is $6,000. Combined federal tax so far is $27,000, and $39,000 stays in the corporation. The LLC owner's tax on the $100,000 profit still depends on income tax, self-employment tax and any qualified business income deduction, so the example does not identify a universal winner.

Different for you?

• Several founders, outside funding or a planned stock sale: document who will own what, expected profit, annual cash needs, asset values and the likely sale form before issuing interests; get business formation help.
• An existing LLC with assets or past elections: changing form can itself affect tax; see changing your business structure.
• A nonresident owner: US tax and filing can change by owner residence (IRS: nonresident taxation); see forming and running a company from abroad.
• A Canadian-resident owner: Canada may classify a US LLC differently (CRA: treaty guidance); see setting up a US business as a Canadian resident.
• You hold rental property: Section 1202's active-business test excludes leasing businesses; see rental property in an LLC.
• Large early losses or an S corporation election: see business losses or S corporation status, respectively.