Entity choice is one of the highest-leverage tax decisions a business owner makes. The same $300,000 of business income can produce meaningfully different after-tax results depending on entity structure - due to differences in self-employment tax, the QBI deduction, corporate tax rates, fringe benefit deductibility, and exit tax treatment. There is no universally optimal structure; the right answer depends on income level, growth trajectory, need for outside capital, benefit requirements, and exit strategy.
Individual ordinary income rates: 10%, 12%, 22%, 24%, 32%, 35%, 37%
Long-term capital gains rates: 0% / 15% / 20% (+ 3.8% NIIT above thresholds)
C-corporation flat rate: 21%
SE tax rate: 15.3% on first $184,500, 2.9% above
QBI deduction (§199A): 20% of qualified business income - permanent under OBBBA
S-corp FICA on reasonable salary: 15.3% on salary only (not distributions)
| Factor | Sole Prop / SMLLC | Partnership / MMLLC | S-Corporation | C-Corporation |
|---|---|---|---|---|
| Federal income tax on business income | Owner's ordinary rate (up to 37%) | Partners' ordinary rates (up to 37%) | Shareholders' ordinary rates (up to 37%) | 21% flat at entity level; dividends taxed again at 23.8% (20% + 3.8% NIIT) |
| SE / FICA tax on profits | 15.3% on 92.35% of all net profit | 15.3% on general partner / active member income | FICA only on reasonable W-2 salary; distributions not subject to FICA | No SE tax; salaries subject to FICA but profits retained at 21% |
| QBI deduction (§199A) | 20% deduction available; effective top rate ~29.6% | 20% deduction available on qualified income | 20% deduction available; W-2 wage limitation applies at higher incomes | Not available - §199A applies only to pass-through income |
| Health insurance deduction | 100% above-the-line (§162(l)) | Partners: 100% above-the-line (§162(l)) | 2%+ shareholders: included in W-2 wages, then deducted above-the-line | Fully deductible as business expense; no income inclusion for employees |
| Retirement plan contribution limits | Solo 401(k) or SEP: up to $70,000 (2026) | Partners: same as sole prop; compensation-based | Based on W-2 salary - employer + employee contributions up to $70,000 | Based on W-2 salary from corporation; up to $70,000 |
| Capital structure flexibility | None - single owner | Multiple classes of partnership interest; profit/loss special allocations | One class of stock only; limited to 100 shareholders; no nonresident alien shareholders | Common and preferred stock; unlimited shareholders; no restrictions |
| Raising outside capital / VC | Not feasible for institutional capital | Possible but uncommon for VC; used for real estate and private equity | S-corp restrictions (one class, 100 shareholders, no corporate shareholders) preclude VC | Standard vehicle for venture capital; C-corp required for most institutional investors |
| QSBS exclusion (§1202) | Not available | Not available | Not available - S-corps do not qualify | 100% gain exclusion on sale of qualifying C-corp stock held 5+ years (up to 10x basis) |
| Exit: asset vs. stock sale | Single level of tax; gain on assets sold | §751 hot asset rules; generally single level of tax | §338(h)(10) election available - buyer gets asset treatment, seller pays only one level of tax | Stock sale: one level (capital gains). Asset sale: double tax (21% corp + dividend tax on distribution) |
| Accumulated earnings / retained capital | All income taxed currently; no deferral | All income taxed currently to partners regardless of distributions | All income taxed currently to shareholders regardless of distributions | Profits retained inside corp at 21%; deferred until distribution or sale |
| Built-in gains tax (BIG) | Not applicable | Not applicable | §1374 BIG tax applies if converted from C-corp within prior 5 years | Not applicable |
| State filing complexity | Schedule C on personal return; typically no separate entity return | Form 1065 required; state composite returns for nonresident partners | Form 1120-S required; payroll compliance; state returns | Form 1120 required; separate entity returns in all states with nexus |
The S-corporation's primary advantage over a sole proprietorship or partnership is SE tax savings on distributions. The breakeven depends on state-specific compliance costs (payroll service, 1120-S preparation, state fees) versus the SE tax saved on distributions above the reasonable salary. As a rough rule of thumb at 2026 rates:
The C-corp is often dismissed as double-taxed and inefficient for small businesses. In specific circumstances, it is the optimal structure. The 21% corporate rate combined with indefinite deferral of profits inside the entity is valuable for businesses that reinvest substantially all earnings and do not need to distribute profits annually. The comparison to pass-through taxation depends entirely on the distribution pattern.
C-corps are clearly optimal when: (a) the business needs VC or institutional investment - S-corp restrictions preclude this; (b) the §1202 QSBS exclusion is expected to apply - 100% gain exclusion on qualified C-corp stock is one of the most valuable provisions in the code; (c) the business generates profits that will be reinvested for years rather than distributed - deferring income inside the entity at 21% vs. paying 37% currently has real value; or (d) the business provides substantial employee benefits that are more favorably treated inside a C-corp.