TL;DR - Your Quick Answer
- Raising VC or want QSBS inside 12–24 months? Start as a Delaware C-Corp.
- Not sure about VC? Start as an LLC (partnership-taxed) for flexibility and pass-through taxation; revisit the structure as profits and hiring grow.
- Already profitable with simple ownership? If eligible, consider an S-Corp election for payroll and distribution tax savings when regularly distributing profits.
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Quick Compare: C-Corp vs LLC vs S-Corp (1-Minute View)
Note: An S-Corp is a tax election (Form 2553) that limits the number of owners and the types of stock classes. See below for details.
The Decision Framework (2 Steps)
This guide is structured around how you currently operate. It provides clear triggers to revisit your decision.
Step 1. Will you raise institutional venture capital in the next 12–24 months?
If the answer is yes, start as a Delaware C-Corp. That is the structure investors expect for preferred stock rounds, and it starts the Qualified Small Business Stock holding period (discussed below).
If you are unsure, remember the one-way door: moving from a C-Corp to an LLC later can create tax problems, while moving from an LLC to a C-Corp is usually straightforward if the structure is correct. If there is any realistic chance you will pursue venture capital on that timeline, lean C-Corp. Otherwise, go to Step 2.
Step 2. If you are not raising venture capital soon: LLC first, or an S-Corp election?
The default choice is an LLC taxed as a partnership. This provides maximum flexibility: profits can be reinvested or distributed as cash flow allows, profits interests can be granted to contributors without immediate tax if structured correctly, and ownership can evolve without restrictions.
See Also: SAFE vs. Convertible Note for LLCs: Tax Traps You Need to Know
The alternative is to form a corporation and immediately elect S-Corp status. This approach makes sense only if all of the following are true: ownership will remain simple (U.S. individuals only, no more than 100 owners), profits will be distributed regularly rather than reinvested, and the tax savings justify the added administration. S-Corps require reasonable W-2 salaries with excess profits distributed, which can save $15,000 to $30,000 annually on self-employment taxes for profitable operations.
Choose an LLC if there is uncertainty about ownership structure, profit distribution patterns, or future financing needs. The S-Corp constraints (single stock class, no entity investors, no profits interests) are rigid. An LLC can always elect S-Corp status later once conditions stabilize. If a venture round appears later and the entity is already a corporation, the S-Corp election can be revoked to operate as a C-Corp by tax filing, while an LLC would require a legal conversion to a corporation and additional equity cleanup.
Other factors in entity selection are QSBS treatment, founder compensation, and the impact of multi-state operations.
QSBS for Founders (2025 Rules & Timing)
Qualified Small Business Stock (QSBS) is a tax benefit that allows eligible founders, investors, and employees of qualifying small businesses to exclude some or all of the capital gains from federal taxes when they sell their stock. The simple math: if you sell C-Corp stock held for 5+ years, you could save up to $10M in federal taxes. But it only works if you’re a C-Corp from day one of issuing that stock. Converting from an LLC? Your QSBS clock starts over completely.
Core requirements you must meet
- Must be a domestic C-Corp when stock is issued
- Active business test: 80% or more (by value) of assets must be used in active business, not passive investments or real estate
- Qualifying industries: most tech companies qualify, but certain services and financial activities are excluded
- Gross-assets limit: $50M or less at issuance for pre-July 5, 2025 QSBS; increased to $75M (inflation-indexed) for stock issued after July 4, 2025 under OBBBA 2025
New holding period rules (post-July 4, 2025)
- 3 years: 50% exclusion
- 4 years: 75% exclusion
- 5 years: 100% exclusion
(Old 5-year rule remains for pre-July 5, 2025 stock)
Redemption pitfall
Significant issuer redemptions near issuance can destroy QSBS eligibility; coordinate with counsel before any buybacks.
State conformity varies
California doesn’t conform at all. New York partial. Check whether your state follows federal §1202 treatment.
Founder Compensation: C-Corp vs LLC vs S-Corp (Quick Take)
C-Corp
Founders are employees with W-2 payroll. Salaries and bonuses are deductible at the company level and taxed once personally. Dividends are subject to double taxation: first at the corporate level, and then again at the personal level. That said, C-Corps shine when profits are going to be reinvested anyway: Unlike the partnership taxation regime (which often applies when LLCs are used), retained profits aren’t taxed to owners until distributed, making C-Corps more efficient for growth-focused setups. In VC-backed companies, this is often acceptable since profits are typically reinvested in R&D and growth rather than distributed to owners. It’s the trade-off for VC compatibility and QSBS potential.
LLC taxed as a partnership
Profits pass through via K-1s, taxed once at personal rates, without any corporate-level tax (in contrast to the treatment of dividends). Active owners owe self-employment tax on their full share of income, plus surtax for high earners. This suits setups where profits are fully distributed, since C-Corp double taxation is avoided. Keep in mind, though, if profits are retained for reinvestment, owners still pay taxes on them, often requiring “tax distributions” to cover the bill.
S-Corp
For founders regularly pulling profits, S-Corps are often the most tax-efficient option. Why? They require a reasonable W-2 salary (subject to payroll taxes), but excess profits are distributed free of SE taxes—skipping that hit on the non-salary portion. This can save $15K–$30K+ annually vs. partnership-taxed LLCs for profitable teams (e.g., on $300K total comp, pay SE only on a $100K salary). That said, S-Corps are more rigid in governance and financing (e.g., one stock class, U.S.-only owners max 100, no profits interests), so LLCs taxed as partnerships are often chosen for their increased flexibility.
Multi-State & Remote Teams (Tax and Compliance Impact)
As remote work becomes standard and teams spread across states, the choice of business structure has major tax implications. Each state where employees or operations are located can create filing obligations, but the impact varies between LLCs and corporations.
Pass-through entities (LLCs and S-Corporations)
Owners can be required to file personal returns in every state where the business has a nexus (for example, where employees work). Multi-state K-1s add time and cost for each owner. Composite returns and elective pass-through entity taxes can reduce owner filings, but they add compliance steps and, in some states, impose an entity-level tax.
C-Corporations
The company, not the owners, files in the states where it has nexus. Shareholders generally file only in their home state (plus any states where they have other income). For distributed teams, this centralization often outweighs the added corporate compliance as headcount grows.
If your team spans several states today, or will within 12–24 months, factor administrative burden into your choice. Many founders move to a C-Corporation at this stage for simplicity.
When to Reassess an LLC (Stay or Convert)
For founders who chose an LLC, the structure isn’t a temporary waiting room—many successful businesses operate indefinitely as LLCs. Strategic corporate investors, unlike traditional VC funds constrained by their LPs’ tax requirements, regularly invest in LLCs. Banks evaluate creditworthiness regardless of entity type. Revenue-based financing and government contracts work equally well.
The LLC structure offers two optimization paths worth ongoing evaluation:
Staying LLC with an S-Corp election
Once profitable with consistent owner draws exceeding $60,000 annually, the S-Corp election detailed in the Founder Compensation section above can save $15,000-30,000 in self-employment taxes. Remember the constraints: U.S. individuals only, maximum 100 shareholders, one stock class, and no profits interests. An LLC that elects S-Corp status must both revoke the election AND complete the state-level entity conversion described below if C-Corp becomes necessary—coordinate both steps with tax counsel.
Converting to a C-Corp
The signals for conversion remain the same as the day-one decision factors: institutional VC term sheets materializing (not angels or strategics), broad employee stock option needs emerging, QSBS opportunity with 5+ year horizon crystallizing, or multi-state K-1 complexity becoming untenable. When these triggers appear—not at arbitrary revenue milestones—proceed to the conversion playbook below.
Many LLCs never convert and shouldn’t. The decision depends on specific business trajectory and funding sources, not growth metrics alone. Regular reassessment ensures the structure matches actual, not aspirational, business needs
The LLC to C-Corp Conversion Playbook
Changing from an LLC to a C-Corp is governed by state law. Depending on the jurisdiction, this may require a merger (or other transaction) or can be accomplished through statutory conversion (by filing to change the entity type). Delaware excels here with its simple statutory conversion process, which permits a simple filing of a certificate of conversion and incorporation, often expedited in days with fees under $500. Opt for Delaware if possible for this efficiency.
See Also: SAFE vs. Convertible Note for LLCs: Tax Traps You Need to Know
The real timeline and cost depend on cleanup:
- Cap table scrub and equity restructuring
- Equity plan adoption
- 409A valuation (required before granting options)
- Tax structuring to ensure tax-free treatment
Aim to complete conversion before, not during, a priced round or major commercial closing. With proper structuring under IRC Section 351, the conversion can be tax-free; however, be aware of potential issues with basis, liabilities, and profit-interest vesting, as well as cash-out quirks.
Not sure which path fits? Schedule a meeting here
Frequently Asked Questions: Answers for Founders
Can I start as an LLC and convert without tax penalties?
Does converting from an LLC restart my QSBS clock?
What if I’m profitable and don’t want outside investment?
Do all equity investors require a C-Corp?
How does entity choice affect how I pay myself?
- C-Corporation: W-2 wages through payroll; dividends are double-taxed.
- LLC taxed as a partnership: Active owners generally owe self-employment tax on their share of business income and on guaranteed payments.
- S-Corporation: Pay a reasonable W-2 salary; amounts beyond that are generally not subject to self-employment tax.
