Quick Answer

Pass-through taxation means business income is taxed once on your personal return, while double taxation means profits are taxed first at the corporate level (21%) and again on dividends you receive (up to 23.8%). With the QBI deduction expiring in 2026 and top individual rates reverting to 39.6%, the gap between pass-through and double-taxation outcomes has narrowed dramatically—making entity choice more consequential than it has been in years. The right structure can save—or cost you—tens of thousands of dollars per year.

Key Takeaways

• Pass-through entities (LLCs and S Corps) tax business income once at the owner’s individual rate, avoiding the corporate-level tax entirely—but in 2026, that individual rate could reach 39.6% without the QBI deduction.
• C Corps face double taxation: 21% at the corporate level plus up to 23.8% on qualified dividends, producing a combined effective rate as high as 39.8% on distributed profits.
• The QBI sunset changes the math: Losing the 20% pass-through deduction adds up to 7.4 percentage points to effective rates for LLC and S Corp owners, making C Corps relatively more attractive for retained-earnings strategies.
• S Corp salary optimization still matters: Even without QBI, S Corps avoid self-employment tax on distributions—a 15.3% savings that LLCs taxed as sole proprietorships cannot match.
• State taxes amplify or reduce the gap: In high-tax states like California, the combined federal-plus-state pass-through rate can exceed 50%, while C Corps face their own state corporate taxes on top of the 21% federal rate.
• Retention strategy is the deciding factor: If you need to reinvest most profits, C Corps avoid the second layer of tax on undistributed earnings; if you distribute all profits annually, pass-through is almost always more efficient.

---

What Is Pass-Through Taxation?

Pass-through taxation is the default treatment for most small businesses in the United States. The entity itself does not pay federal income tax. Instead, profits and losses “pass through” to the owners’ individual tax returns, where they are taxed at personal income tax rates.

Entities that use pass-through taxation by default include:

• Sole proprietorships — single-owner unincorporated businesses
• Single-member LLCs — treated as disregarded entities by default (see our single-member LLC tax guide)
• Multi-member LLCs — treated as partnerships by default
• S Corporations — an elected tax status that also uses pass-through treatment but with key differences in self-employment tax
• Partnerships — general and limited partnerships

The critical feature is that the business income appears on your Form 1040 (via Schedule C, Schedule E, or a K-1), and you pay tax once at your individual marginal rate.

2026 Pass-Through Rates in Practice

After the TCJA sunset, individual tax brackets revert to pre-2018 levels. Here is what pass-through owners face in 2026:

Taxable Income (Married Filing Jointly)	2026 Marginal Rate	Effective Rate Example
$0 – $23,200	10%	10.0%
$23,201 – $94,300	15%	~13.5% at $75,000
$94,301 – $201,050	25%	~19.2% at $150,000
$201,051 – $383,900	28%	~24.1% at $300,000
$383,901 – $487,450	33%	~28.0% at $450,000
$487,451 – $731,200	35%	~30.2% at $600,000
$731,201+	39.6%	~33.8% at $1,000,000

Before the TCJA sunset, the top rate was 37% and the 20% QBI deduction effectively reduced the top pass-through rate to 29.6%. In 2026, without QBI, the same income is taxed at up to 39.6%—a swing of 10 percentage points.

What Is Double Taxation?

Double taxation occurs when a C Corporation earns profit, pays corporate income tax on that profit, and then distributes the remaining after-tax profit to shareholders as dividends. Those dividends are taxed again on the shareholders’ personal returns.

Here is the mechanism step by step:

1. Corporate level: The C Corp pays 21% federal tax on net income
2. Distribution: After-tax profits are distributed as dividends
3. Individual level: Shareholders pay tax on dividends received (0%, 15%, or 20% plus 3.8% Net Investment Income Tax)

The Combined Double-Tax Rate

For a business owner in the top bracket receiving qualified dividends from their C Corp:

Tax Layer	Rate	Cumulative Effect
Corporate tax	21.0%	$79 of every $100 remains
Dividend tax (20% + 3.8% NIIT)	23.8% on $79	$61.20 of every $100 remains
Combined effective rate	38.8%	$38.80 tax per $100 profit

For non-qualified dividends or ordinary dividends (which some closely-held C Corp distributions may be classified as), the individual rate could be as high as 39.6% + 3.8% NIIT = 43.4%, pushing the combined rate above 55%.

Side-by-Side Comparison: Pass-Through vs Double Taxation

Let us compare the total tax burden under each system using a realistic 2026 scenario.

Scenario: $300,000 Net Business Income (Married Filing Jointly)

Tax Item	LLC (Sole Prop)	S Corp	C Corp
Gross business income	$300,000	$300,000	$300,000
Self-employment tax (15.3%)	$22,950 (on $300K minus 92.35% calculation)	$0 on distributions	N/A
Reasonable salary (S Corp)	N/A	$120,000	N/A
SE tax on salary	Included above	$18,360	N/A
Corporate tax (21%)	$0	$0	$63,000
Remaining for owner	$300,000	$300,000	$237,000
Pass-through income on K-1/W-2	$300,000	$300,000	$120,000 salary
Dividend distribution	$0	$0	$237,000
Individual income tax (est.)	~$66,750	~$60,200	~$23,800 (salary) + ~$50,900 (dividends)
Total federal tax	~$89,700	~$78,560	~$155,660
Effective rate	29.9%	26.2%	38.9%

In this scenario, the S Corp saves roughly $11,140 compared to the LLC (primarily from avoiding self-employment tax on distributions) and $77,100 compared to the C Corp.

Scenario: $1,000,000 Net Business Income (Retained in Business)

Now consider a business earning $1,000,000 where the owner wants to retain most earnings for growth:

Tax Item	LLC (Sole Prop)	S Corp	C Corp (retain all)
Gross business income	$1,000,000	$1,000,000	$1,000,000
SE tax / payroll tax	~$28,050	~$23,000 (on $170K salary)	~$13,005 (on $170K salary)
Corporate tax (21%)	$0	$0	$210,000
Individual income tax	~$320,000	~$298,000	~$33,600 (on salary only)
Total federal tax	~$348,050	~$321,000	~$256,605
Effective rate	34.8%	32.1%	25.7%

When profits are retained, the C Corp only pays the 21% corporate rate on undistributed earnings—avoiding the second layer of individual tax entirely. The C Corp saves $91,445 compared to the LLC and $64,395 compared to the S Corp in this retention scenario.

This is the core trade-off: distribute everything → pass-through wins; retain everything → C Corp wins.

Why the 2026 TCJA Sunset Changes the Equation

The TCJA sunset fundamentally shifts the pass-through vs double-taxation calculus. Here is why:

The QBI Deduction Was the Great Equalizer

From 2018 through 2025, the 20% Section 199A QBI deduction effectively reduced the top pass-through rate from 37% to 29.6%. This gave pass-through entities a significant cushion against the C Corp’s 21% rate.

In 2026, that cushion disappears. A pass-through owner in the top bracket now faces 39.6%—nearly matching the C Corp’s combined double-tax rate of ~38.8% on distributed profits.

Metric	2025 (with QBI)	2026 (without QBI)
Top pass-through rate	29.6% (37% × 80%)	39.6%
C Corp distributed effective rate	~38.8%	~38.8%
Pass-through advantage	+9.2 percentage points	−0.8 percentage points

The pass-through advantage on distributed income shrinks from 9.2 percentage points to effectively zero. For a deeper dive into these expiring provisions, see our TCJA sunset entity selection analysis.

Standard Deduction Reduction Increases Taxable Income

The standard deduction reverts from approximately $15,000 (single) / $30,000 (MFJ) to roughly $8,000 / $16,000. Pass-through owners lose an additional $14,000 in deductions at the MFJ level, adding ~$5,500 in tax at the 39.6% bracket.

Bracket Compression Means More Income Taxed at Higher Rates

Pre-TCJA brackets are narrower, meaning more income gets pushed into higher marginal rates more quickly. A business owner with $400,000 in pass-through income will see significantly more of it taxed at 33% and 35% rather than 28%.

Self-Employment Tax: The Hidden Pass-Through Cost

One often-overlooked difference between entity types is self-employment tax. This 15.3% tax (12.4% Social Security + 2.9% Medicare) applies differently depending on entity structure:

LLC Taxed as Sole Proprietorship

All net business income is subject to self-employment tax. In 2026, the Social Security wage base is expected to be approximately $176,100.

• Social Security (12.4%): First $176,100 of net earnings
• Medicare (2.9%): All net earnings, no cap
• Additional Medicare (0.9%): Earnings above $250,000 (MFJ)

On $300,000 of LLC income, self-employment tax totals approximately $22,950.

S Corp Election

Only the reasonable salary is subject to employment tax. Distributions above salary are not subject to Social Security or Medicare tax. Our S Corp salary distribution guide covers this in detail.

On $300,000 of S Corp income with a $120,000 reasonable salary:

• Employment tax on salary: ~$18,360
• Employment tax on $180,000 distribution: $0
• SE tax savings vs LLC: ~$4,590

C Corporation

The C Corp itself does not pay self-employment tax. The owner-employee pays payroll taxes on their W-2 salary only—the same treatment as the S Corp. However, all remaining corporate profit is still subject to the 21% corporate tax regardless of distribution.

When Pass-Through Taxation Wins

Pass-through taxation is almost always better when:

1. You Distribute All Profits Annually

If you take all business income as personal compensation each year, pass-through avoids the second tax layer entirely. With the 2026 rates:

• LLC/S Corp effective rate: 26–35% depending on income level and salary optimization
• C Corp distributed effective rate: ~38.8%

2. Your Income Is Below the Top Bracket

For business owners with net income below $200,000 (MFJ), the reverted individual rates of 15–25% are well below the C Corp’s combined 38.8%. Pass-through remains the clear winner.

3. You Have Business Losses

Pass-through entities allow owners to deduct business losses against other income (subject to basis, at-risk, and passive activity rules). C Corp losses stay trapped at the corporate level and can only offset corporate income.

4. You Qualify for the S Corp Salary Strategy

S Corp owners who set a reasonable salary and take the rest as distributions avoid self-employment tax on the distribution portion—a direct savings of 15.3%. This strategy remains valuable even without the QBI deduction. For guidance on whether this makes sense for you, see our when to convert LLC to S Corp analysis.

When C Corp Double Taxation Can Win

Despite the double tax, C Corps can be optimal in specific situations:

1. You Retain Most Earnings for Reinvestment

If your business needs to reinvest 70%+ of profits, the C Corp pays only 21% on retained earnings. Pass-through owners pay individual rates on all income—whether distributed or not.

Example: A tech startup earning $2,000,000 that needs to reinvest $1,600,000 for growth:

• C Corp: $420,000 corporate tax on full $2M; owner pays individual tax only on $400,000 salary/dividends
• S Corp: Owner pays individual tax on entire $2,000,000 K-1 income (~$700,000+ in tax), even though $1.6M stays in the business

2. You Are Building for an Acquisition

C Corp stock can qualify for Section 1202 Qualified Small Business Stock (QSBS) exclusion—if held for 5+ years, up to $10,000,000 (or 10x basis) of gain is excluded from federal income tax. This is a massive benefit that pass-through entities cannot access.

3. You Want Fringe Benefit Deductions

C Corps can deduct certain fringe benefits (health insurance, disability, life insurance) for >2% shareholders that pass-through entities cannot. This can be worth $10,000–$25,000 per year in additional deductions.

4. You Have Multiple Owners with Different Needs

C Corps offer the most flexibility in ownership classes, preferred distributions, and stock structures. If you have investors with different preferences, the C Corp structure accommodates this more easily than pass-through entities.

The Break-Even Analysis: When Does Switching Make Sense?

The decision ultimately comes down to a break-even calculation. Here is a framework for determining when the C Corp becomes more efficient:

The Distribution Threshold

For every dollar of profit:

Retention %	LLC/S Corp (39.6% rate)	C Corp (21% + dividend tax)	Winner
0% distributed	39.6% effective	38.8% effective	C Corp (barely)
25% retained	39.6% effective	21% on 75% retained + 38.8% on 25% distributed = 25.5%	C Corp
50% retained	39.6% effective	21% on 50% retained + 38.8% on 50% distributed = 29.9%	C Corp
75% retained	39.6% effective	21% on 75% retained + 38.8% on 25% distributed = 25.5%	C Corp
100% retained	39.6% effective	21.0%	C Corp

Key insight: In 2026, the C Corp is competitive even at 100% distribution because the QBI deduction expiration pushed pass-through rates up to 39.6%. Before the sunset, pass-through won at all distribution levels below ~70% retention.

State Tax Impact

State taxes add another layer. In a state with no income tax (Texas, Florida, Nevada):

• Pass-through owners face only the federal rate
• C Corps also face only the federal rate
• The comparison above holds

In a high-tax state (California, 13.3% top rate):

• Pass-through: 39.6% + 13.3% = 52.9% combined
• C Corp corporate: 21% + 8.84% (CA corporate) = 29.84% on retained earnings
• C Corp distributed: 29.84% + (23.8% × remaining) = ~46.4% combined on distributed profits

In California, the C Corp’s advantage on retained earnings is enormous (29.84% vs 52.9%), but on fully distributed profits the gap narrows significantly. For a complete state-by-state comparison, see our LLC vs C Corp guide.

Real-World 2026 Tax Calculations

Let us walk through three real-world scenarios with 2026 numbers.

Scenario A: Freelance Consultant, $150,000 Profit

Anna is a single freelance consultant operating as a single-member LLC in a no-income-tax state.

Entity	SE/Payroll Tax	Income Tax	Total	Effective Rate
LLC (sole prop)	$21,375	$27,750	$49,125	32.8%
S Corp ($80K salary)	$12,240	$26,200	$38,440	25.6%
C Corp	$12,240 (on salary)	$21,000 (corp) + $5,700 (div)	$38,940	26.0%

Winner: S Corp saves ~$10,685 vs LLC. C Corp and S Corp are nearly tied, but S Corp avoids the complexity of corporate tax filings.

Scenario B: Multi-Owner Agency, $800,000 Profit

Ben and Maria co-own a marketing agency in New York (state income tax ~10.9%). They split profits 50/50.

Entity	Federal Tax (per owner)	State Tax (per owner)	Total per Owner	Effective Rate
LLC (partnership)	~$135,000	~$43,500	$178,500	44.6%
S Corp ($150K salary each)	~$122,000	~$43,500	$165,500	41.4%
C Corp (distribute 50%)	~$155,000 (corp + div)	~$55,000	$210,000	52.5%

Winner: S Corp saves $26,000 per owner vs C Corp. The pass-through advantage is clear when distributing profits.

Scenario C: SaaS Startup, $2,000,000 Revenue, Retaining 80%

TechCo is a SaaS startup with $2,000,000 in revenue and plans to retain 80% for product development.

Entity	Federal Tax	Retained for Growth	Effective Rate on Total
S Corp	~$700,000	$1,300,000 (but taxed on full $2M)	35.0%
C Corp	~$420,000 (corp) + ~$38,000 (div on $400K)	$1,542,000	22.9%

Winner: C Corp retains $242,000 more for growth while paying $282,000 less in total tax. The retention advantage is decisive.

Tax Planning Strategies for 2026

Regardless of which entity type you choose, several strategies can help minimize your 2026 tax burden:

For Pass-Through Owners

1. Maximize S Corp salary optimization — Set the lowest defensible reasonable salary to minimize employment taxes. Document your analysis with comparable salary data.

2. Stack retirement contributions — S Corp owners can contribute up to $69,000 (2026 estimate) via a Solo 401(k), reducing both income and self-employment taxes.

3. Use Section 179 expensing — Deduct the full cost of qualifying equipment and software purchases (up to ~$1,220,000 in 2026) rather than depreciating over time.

4. Consider account-based plans — Health Savings Accounts (HSAs), Flexible Spending Accounts (FSAs), and Medical Expense Reimbursement Plans (MERPs) can provide above-the-line deductions.

For C Corp Owners

1. Time dividends strategically — Accumulate earnings at 21% and distribute in lower-income years to minimize the second tax layer.

2. Pay reasonable compensation — Salary and bonuses reduce corporate taxable income while shifting money to the owner at individual rates.

3. Maximize fringe benefits — Use deductible benefits like health insurance, disability, and accountable plans to extract value without triggering dividend tax.

4. Plan for QSBS — If your C Corp qualifies as a QSBS, hold shares for 5+ years before exit to exclude up to $10,000,000 in capital gains.

The Bottom Line

The 2026 TCJA sunset eliminates the QBI deduction that gave pass-through entities a comfortable tax advantage. With top individual rates reverting to 39.6%, pass-through and C Corp rates on distributed income are nearly identical at ~39%. The deciding factor is what you do with your profits:

• Distribute most profits → Pass-through (especially S Corp) wins
• Retain most profits → C Corp wins by a wide margin
• Mixed approach → Run the numbers using our comparison calculator

Entity selection is not permanent, but changing structures has tax consequences. The best time to evaluate is before the 2026 tax year begins—while you still have time to plan, elect, and restructure.

---

Use Our Free Entity Tax Comparison Calculator

Not sure which entity structure minimizes your 2026 tax bill? Our free comparison calculator lets you input your business income, state, distribution plans, and salary preferences to see side-by-side effective tax rates for LLC, S Corp, and C Corp structures. It takes less than two minutes and could save you thousands.

---

Frequently Asked Questions

Does the C Corp 21% tax rate expire in 2026?

No. The 21% flat corporate tax rate enacted by the TCJA is permanent and does not sunset. Only the individual and pass-through provisions (QBI deduction, lower individual brackets, higher standard deduction) expire after December 31, 2025. This is why the C Corp rate remains a stable planning benchmark while pass-through rates fluctuate with expiring provisions.

Can an LLC choose to be taxed as a C Corp to get the 21% rate?

Yes. By filing IRS Form 8832, a single-member LLC can elect to be taxed as a C Corporation, or a multi-member LLC can elect out of partnership taxation into C Corp treatment. This triggers the 21% corporate rate but also introduces double taxation on distributions. You need to weigh the corporate rate savings against the dividend tax on any profits you take out.

How does the Net Investment Income Tax (NIIT) affect pass-through vs C Corp taxation?

The 3.8% NIIT applies to S Corp distributions that exceed a shareholder’s stock basis and to passive S Corp income if the owner does not materially participate. For C Corp dividends, NIIT applies to all qualified dividend income above the $250,000 (MFJ) threshold. In both cases, the 3.8% surtax pushes effective rates higher, but the impact depends on your participation status and total investment income.

What happens if my C Corp accumulates earnings without distributing them?

The IRS imposes an Accumulated Earnings Tax (AET) of 20% on C Corps that retain earnings beyond the reasonable needs of the business without distributing them. The first $250,000 ($150,000 for certain service corporations) is generally presumed reasonable. Beyond that, you need documented business purposes for retention—such as expansion plans, product development, or working capital needs. Failure to justify retained earnings can trigger the penalty.

Is it better to be an S Corp or C Corp for a business with $500,000 in annual profit?

It depends entirely on your distribution strategy. If you distribute all $500,000 annually, the S Corp’s pass-through taxation at ~32% effective rate beats the C Corp’s ~38.8% combined rate by roughly $34,000 per year. If you retain $350,000 for reinvestment and only distribute $150,000, the C Corp pays 21% on retained earnings, potentially saving you $40,000+ compared to paying individual rates on the full $500,000 through an S Corp.

Does switching from an LLC to an S Corp or C Corp trigger immediate tax?

Switching from an LLC to an S Corp (by filing Form 2553) is generally tax-free—the IRS treats it as a change in tax classification, not a taxable event. However, switching from an LLC or S Corp to a C Corp (by filing Form 8832) can trigger a taxable event if the entity has appreciated assets, as the IRS may treat it as a liquidation followed by a contribution. Always consult a tax professional before making entity changes.

How do state taxes affect the pass-through vs double-taxation decision?

State taxes can swing the decision significantly. In states with no income tax (Texas, Florida, Nevada, Wyoming), the federal comparison dominates. In high-tax states like California (13.3% individual, 8.84% corporate) or New York (10.9% individual, 6.5-7.25% corporate), the combined federal-plus-state pass-through rate can exceed 50%, making C Corp retention dramatically more attractive. Some states also impose entity-level taxes on S Corps (e.g., California’s 1.5% S Corp franchise tax) that narrow the pass-through advantage.