Starting a Business? How to Choose the Right Entity Structure

C Corporation or Pass-Through Entity?

For federal tax purposes, business owners generally have two broad paths.

A C corporation pays federal income tax at the corporate level. Shareholders may then owe additional tax when profits are distributed as dividends or when shares are sold. This is commonly referred to as “double taxation.”

A pass-through entity, on the other hand, generally passes taxable income, losses, deductions and credits through to its owners’ individual income tax returns. Pass-through structures can include S corporations, partnerships and LLCs taxed as partnerships, as well as sole proprietorships and single-member LLCs.

Neither structure is automatically better. The right choice depends on the business, its owners and their long-term plans.

Important Tax Factors to Consider

The 21% Corporate Tax Rate

C corporations are generally subject to a flat 21% federal corporate income tax rate. That rate can make the C corporation structure attractive in certain circumstances, particularly when a growing company plans to retain profits rather than immediately distribute them to owners.

However, the possibility of shareholder-level taxation still needs to be considered.

Qualified Small Business Stock

Certain qualifying C corporations may offer another potentially significant benefit.

If the requirements for qualified small business (QSB) stock are satisfied, shareholders may be able to exclude some or potentially all eligible gain when qualifying stock is eventually sold.

The requirements are detailed and include rules involving when and how the stock was acquired, the corporation’s assets, the type of business conducted and how long the stock is held. The source material notes that qualifying stock acquired after July 4, 2025 may qualify for increasing exclusions after three, four and five years.

The Qualified Business Income Deduction

Eligible owners of pass-through businesses may benefit from the Section 199A qualified business income (QBI) deduction.

The deduction generally equals up to 20% of qualified business income, subject to taxable-income and other limitations. Because the rules become more complicated at higher income levels and for certain types of businesses, eligibility should be evaluated individually.

Four Common Start-Up Scenarios

Your expectations for the business can play an important role in choosing an entity.

1. You expect losses during the first several years.
A pass-through structure may provide an advantage because qualifying business losses can potentially flow through to an owner’s individual tax return. Various limitations can apply, however, including passive-loss and excess-business-loss rules.

2. The business will own assets expected to appreciate significantly.
Holding substantially appreciating assets, such as certain real estate or intangible property, inside a C corporation can create unfavorable tax consequences when those assets are eventually sold and the proceeds are distributed. A pass-through entity may be preferable in this situation.

3. The business expects to distribute most of its profits to its owners.
When profits will regularly be paid out, the potential double taxation associated with a C corporation becomes an important consideration. If the owners qualify for a meaningful QBI deduction, a pass-through entity may offer a better result.

4. The business expects to retain profits to fund growth.
A C corporation’s 21% federal income tax rate may become more attractive when profits will remain inside the company to finance expansion. However, the potential QBI deduction available to eligible pass-through owners can significantly change the comparison.

Your Decision Should Go Beyond Taxes

Taxes are important, but they aren’t the only consideration when selecting an entity.

Liability protection, ownership requirements, administrative costs, financing plans and your eventual exit strategy can all influence which structure makes the most sense.

Changing your business structure later can also be complicated or costly. That’s why it’s important to consider both your immediate needs and your long-term plans before making the decision.

Considering starting a business or wondering whether your current entity structure still makes sense? Contact The Pharr CPA Team. We can help you evaluate the tax considerations surrounding your options and determine what questions should be addressed before you make a decision.

This information is provided for general informational purposes and should not be considered individualized tax or legal advice. Consult your tax and legal advisors regarding your specific circumstances.