Should your LLC become a C corporation?

Over the last couple of years, we've seen a steady stream of companies convert from an LLC to a C corporation. A good share of them did it because an outside investor required it, or made clear they'd prefer it, before writing a check. Others are growing, reinvesting everything they earn, and starting to think about a sale three to five years out. Changes to the qualified small business stock (QSBS) rules in 2025 made the C corporation more attractive for that second group than it has been in a long time.

Converting isn't right for everyone, and it's hard to undo. Here's how the two structures compare and how to tell which one fits your plan.

One layer of tax or two

An LLC taxed as a partnership is taxed once. Profits flow through to the owners' returns, and owners can usually take cash out without a second tax. Eligible owners may also get the Section 199A deduction of up to 20% of qualified business income, which is now permanent.

A C corporation pays a flat 21% federal tax on its own income. When it distributes that income as a dividend, shareholders pay up to 23.8% again (20% plus the 3.8% net investment income tax). Fully distributed, the combined federal rate is roughly 40%.

That second layer only applies when cash comes out. If the company keeps its earnings to fund equipment, hiring, or R&D, it pays 21% and nothing more. LLC owners, by contrast, pay tax on their share of profits at rates up to 37% whether or not they receive a dollar. Most LLCs end up making tax distributions just so owners can cover the bill, which pulls cash out of the business.

Where the LLC shines: flexibility

The tax rate gets most of the attention, but for many owners the bigger draw is how much room an LLC gives you to set up the economics your way.

• Allocations don't have to follow ownership. An investor who put in most of the cash can take the early losses or a preferred return. If the operating agreement is drafted properly, the tax follows the deal.
• Cash and property usually come out tax-free. Distributions generally aren't taxed until they exceed an owner's basis. A C corporation that distributes appreciated property pays tax on the gain.
• Rewarding key people is easier. A profits interest gives an employee a share of future growth with no tax when it's granted.

A C corporation is more rigid. Every share in a class is treated the same, and money that comes out as anything other than reasonable salary is usually a dividend.

When investors make the decision for you

In a lot of the conversions we see, an investor started the conversation. Some venture and private equity funds won't invest in an LLC at all, and many that will still ask for a C corporation in the term sheet. Their reasons:

• Their own investors. Funds often have tax-exempt and foreign investors. Flow-through income from an operating LLC can create unrelated business taxable income or effectively connected income for them, plus K-1s and filings in every state where the company operates.
• Standard deal terms. Preferred stock, option pools, and incentive stock options are built for corporations.
• QSBS for them, too. Investors who buy newly issued C corporation stock can qualify for the same exclusion founders can.

If you're raising money, settle the structure before the term sheet arrives. Conversions done mid-deal are where valuation and method get rushed.

QSBS: the payoff on a stock sale

Section 1202 lets shareholders exclude federal tax on gain from selling qualified small business stock. Only C corporation stock qualifies, not LLC interests or S corporation stock.

For stock issued after July 4, 2025, the One Big Beautiful Bill Act made the benefit better:

• 50% of the gain is excluded after three years, 75% after four, and 100% after five
• The cap is the greater of $15 million or 10 times basis, per shareholder, per company
• The company's gross assets can be up to $75 million when the stock is issued

Some businesses don't qualify. Health, law, accounting, consulting, financial services, and restaurants are excluded, and at least 80% of assets must be used in an active business. A food manufacturer can qualify; a restaurant group can't.

How conversion affects QSBS

• The clock starts at conversion. Years as an LLC don't count.
• Pre-conversion value isn't excluded. The company's value at conversion becomes the starting basis, so only growth after that point is eligible. That higher basis does raise the 10-times cap.
• The $75 million test uses that value. A business worth more than $75 million at conversion won't qualify.

In short, converting earlier puts more of the future growth inside the exclusion.

Asset sale or stock sale

How a buyer structures the deal often decides whether a C corporation pays off.

Buyers usually prefer asset deals. They get a stepped-up basis to depreciate and leave old liabilities behind. LLCs handle this well: a purchase of LLC interests is generally treated as an asset purchase, so the buyer gets the step-up and sellers pay one layer of tax, mostly at capital gain rates.

For a C corporation, an asset sale is taxed twice. A stock sale is taxed once and is the only sale where QSBS applies, but the buyer inherits the old basis and may price that in. The C corporation works best when a stock sale is the realistic exit.

What's the long-term plan?

A C corporation tends to fit a company that's growing and reinvesting its earnings, raising outside capital, in a QSBS-eligible field, and realistically looking at a stock sale in the next three to five years.

An LLC tends to fit when owners rely on distributions, the business generates more cash than it can reinvest, the industry is excluded from QSBS, or the likely buyer will want an asset deal.

Most companies fall somewhere in between. That's where modeling both structures with your earnings, distributions, exit value, and state taxes makes the answer clear.

Before you convert

A conversion can usually be done without immediate tax, but two points deserve attention:

• Valuation. Get a defensible fair market value at the conversion date. It sets your QSBS starting point and supports the $75 million test.
• Going back is expensive. Turning a C corporation back into an LLC is generally treated as a taxable liquidation.

The conversion method, liabilities in excess of basis, and state tax rules also shape how it should be done.

How Vallou can help

Entity structuring and QSBS planning are core parts of our practice. We model both structures against your growth and exit plans, confirm whether the business can qualify for QSBS, and handle the conversion and the filings around it, including the final partnership return and the first corporate return.

If you're weighing a conversion, or an investor or buyer has raised it, it's worth walking through the numbers before you decide.