The decision framework
| Factor | C corporation | S corporation | Partnership / LLC |
|---|---|---|---|
| Level of tax | Entity + shareholder (double) | Owner only | Owner only |
| Loss pass-through | No — trapped at entity | Yes, limited by basis | Yes, basis includes entity debt |
| Self-employment tax | N/A (wages only) | Only on wages | Generally on general partner's share |
| Allocation flexibility | None | Strictly pro rata (one class of stock) | Very flexible (special allocations) |
| Owner restrictions | None | ≤100, no NRAs, no entity owners | None |
| QBI deduction | Not eligible | Eligible | Eligible |
IMPORTANT: Pass-through owners get the §199A QBI deduction — made permanent at 20% by OBBBA — while C corporation shareholders do not. That deduction is a central input into any entity-choice comparison, along with whether earnings will be distributed or reinvested.
Reinvestment vs. distribution
A C corporation is more attractive when earnings are retained and reinvested, because the second layer of tax is deferred until distribution. When owners need current cash, the double tax bites immediately and pass-through treatment usually wins.
Conversion consequences
| Conversion | Typical consequence |
|---|---|
| C → S | No immediate entity-level tax, but exposure to BIG tax and excess net passive income tax; existing E&P persists |
| S → C | Generally straightforward; post-termination transition period rules apply to distributions |
| Partnership → corporation | Can often be structured tax-free under §351 if control requirements are met |
| C → partnership/LLC | Deemed liquidation — gain recognized at both corporate and shareholder levels. Usually prohibitively expensive. |
EXAM TIP: The asymmetry is the point: moving into corporate form is often tax-free; moving out of C corporation form is generally a taxable liquidation. That one-way door is exactly why the initial entity choice deserves care.