C Corps vs. LLCs: Why “Double Taxation” Is A Myth For Startups

Jason D. Rowleyby Jason D. Rowley • 7 min readpublished June 23, 2022
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In the US businesses are taxed on the money they make. Revenue can be taxed through sales taxes, and profits are taxed as corporate income.

Tax stuff can sometimes be confusing to startup founders. There are tons of myths and folk wisdom about taxation and how to reduce its accounting and financial burden on companies.

You might’ve heard that C Corporations are taxed more than Limited Liability Companies (LLCs), that income is taxed twice. Spoiler alert: that last part is technically true, but double taxation is not an issue for startups. It’s merely a myth!

In this article we’re going to go over the following:

  • The basics of corporate income taxes
  • The main differences between how corporate income is taxed for LLCs vs C Corporations
  • Why incorporating as a C Corporation makes more sense for tech startups, from a tax perspective

Corporate Income Tax 101

In the U.S. “corporate income” is defined as profit: the money left over after a company makes more money than it spends over a period of time.

Accordingly, corporate income tax is collected on that profit, and in 2022 the U.S. federal corporate income tax is around 21%.

Many states levy separate corporate income taxes, which can range from as little as 0% to as much as 11.5%, depending on the state. Additionally, some municipalities have their own corporate income taxes, but for the sake of this guide we’re going to focus on corporate income taxes at the federal level.

LLCs vs. C Corporations: How They Pay Income Taxes

From a tax perspective, income (profits) generated by LLCs and C Corporations is treated very differently. In short, there is a separate corporate income tax paid by C Corporations, but there’s no separate income tax paid by LLCs. The specifics are a little more tricky, so let’s dive into it.

Let’s start with LLCs.

LLCs are treated as pass-through entities, which means the profits (and losses) they generate are transferred to the members of the LLC and get reported as individual income on Form 1040. A single-member LLC is treated as a disregarded entity, which means that its profits and losses are directly attributed to its owner and there are no additional filing requirements. Multi-member LLCs issue IRS Form K-1s on an annual basis, and the profits (or losses) reported by the LLC are split according to each member’s proportional share of the company.

To reiterate, regardless of the number of members in an LLC, income (and losses) are taxed as individual income, which on a marginal basis can be taxed at a rate of up to 37% in 2022. So, if an LLC has 2 members with equal stakes in the business and generates $1.5M in profit, each member will report $750,000 in income to the IRS. At current tax brackets, each member will pay roughly $237,000 in taxes, at an effective rate of 31.6%, leaving each with around $513,000 to take home (assuming no other income or deductions).

Now let’s look at C Corporations.

C Corporations are, from a legal standpoint, treated as their own distinct entities. In this regard, that old saw of “corporations are people, my friend” holds true, at least from an income tax perspective.

As we said earlier, corporate income is taxed at a rate of around 21%. Using numbers from the scenario above, a corporation which generated $1.5M in profit would have to pay $315,000 in federal corporate income taxes, leaving $1,185,000 in earnings to either save or distribute to shareholders. If those earnings are distributed to shareholders, such as via a dividend payment, those distributions are usually taxed as ordinary income to shareholders. (Note: Under certain conditions, dividends from publicly traded companies can be taxed as capital gains.) That’s what folks mean when they say there is “double taxation” of corporate income.

However, for startups (and even a lot of public companies), double taxation is not really a factor for executives, investors, employees, and other stakeholders in a corporation. In other words, the myriad benefits of starting up as a C Corporation far outweigh the risk of additional tax burden, since double taxation is almost always a non-issue. Let’s see why.

Double Taxation Is A Non-Issue For Startups

While it’s true that corporate income can be taxed twice (first as corporate income tax, and then as individual income tax), there are many reasons why the vast majority of startups won’t have to worry about it.

Here are a few of those reasons:

  1. Early-stage startups, almost by design, are not profitable. Most startups don’t make any money in their first few years of existence. Building a product costs money and can take a long time, and it’s hard to generate revenues (let alone profits) without a product in the market. And, heck, some companies go public without ever turning a profit, including recent examples like Airbnb and Palantir Technologies.
  2. When startups do generate revenue, it’s reinvested in growth. Even when a startup is generating revenue, all of that money is getting reinvested into the business to accelerate its growth. This happens with some big public companies too; famously, Amazon operated at break-even or unprofitably for years as it reinvested its (sizable) revenues into R&D and business expansion.
  3. Startups rarely issue dividends. Since startup companies rarely operate profitably, and that any money taken off the table through dividend payments to shareholders is money that can’t be invested in growing the business (and, thus, the valuation of the company), it doesn’t make sense for startups to issue dividends.

The job of a startup founder and her leadership team is to grow the value of her company’s equity as quickly as possible. That’s how startup shareholders—ranging from founders and employees to investors and advisors—get their big payday.

The secondary advantage to the strategy of rapidly growing the company’s valuation is that, if and when a startup goes public or gets acquired, the proceeds from that liquidity event are most likely going to be taxed as capital gains, and may be eligible for QSBS exemptions—the latter of which could save a founder potentially tens of millions of dollars in taxes. In other words, despite the theoretical possibility of double taxation, the reality is that there are far more tax advantages to corporations and their shareholders when pursuing a high-growth startup strategy.

Summary: The Brass Tacks Of Corporate Income Taxes

  • LLCs and C Corporations are treated very differently from a tax standpoint.
  • LLCs are pass-through entities, which means that their income isn’t taxed directly; rather, members of the LLC are responsible for paying their share of taxes on profits through individual income taxes.
  • As standalone legal entities, corporations are responsible for paying a separate corporate income tax on profits, and any profits distributed through dividends to shareholders are again taxed as individual income (but sometimes as capital gains).
  • Double taxation may be real but it’s a non-issue for startups, since high-growth companies don’t typically generate taxable profits for several years (if ever).
  • There are many other tax advantages to forming a new company as a C Corporation—such as the possibility of qualifying for QSBS exemption—which far outweigh the unlikely risk of double taxation.

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Jason D. Rowley

Jason D. Rowley is Head of Content at Capbase. A former venture capital data journalist and researcher, he lives in Chicago with his dog Zeus.

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