BUSINESS TAX · 6 MIN READ

S Corp vs. LLC vs. C Corp: Which Saves Me the Most on My Taxes?

Business owners often ask, “Which entity saves me the most on my taxes?” or “Should I form an LLC?” The answer depends on your profit level, how much you take out of the business, your plans for growth or sale, and your state. This guide explains how each structure is taxed and where each may offer advantages.

A common confusion: an LLC is not a tax classification

An LLC (limited liability company) is a state-law entity that provides liability protection. For federal tax purposes, an LLC can be taxed as:

• A disregarded entity (the default for a single-member LLC), generally reported as a sole proprietorship when owned by an individual
• A partnership (the default for most domestic multi-member LLCs)
• An S corporation (by election, Form 2553)
• A C corporation (an LLC can elect corporate tax treatment using Form 8832)

“S corp vs. LLC” is really a comparison of tax treatment rather than a choice of legal entity. Many S corporations are LLCs that made a valid S election by Form 2553. So the real question you must ask yourself is what tax structure fits your vision for your business? To answer that question, let’s discuss how these structures are taxed.

How each structure is taxed

LLC taxed as a sole proprietorship or partnership

• Profit generally passes through to the owners and is taxed at their applicable rates, whether or not it is distributed.
• Net earnings from an active trade or business are generally subject to self-employment tax. Treatment depends on the activity and the owner’s status; rental income and certain other items may be treated differently. Social Security wage limits and Medicare rules also apply.
• You may qualify for the qualified business income (QBI) deduction under § 199A, which is generally up to 20% of qualified business income, subject to limits for higher earners and certain service businesses.
• Simple to run, with the least administrative cost.

S corporation

• Generally a pass-through entity: shareholders report their share of income on their returns, whether or not the income is distributed. Certain entity-level taxes can apply.
• Owner-employees must be paid reasonable compensation through payroll. That salary is subject to payroll taxes.
• After reasonable compensation is addressed, non-wage distributions generally are not subject to employment taxes. This is a potential S corporation advantage; distributions and shareholder basis still require separate tax analysis.
• Limits: no more than 100 shareholders, one class of stock, and only eligible shareholders (generally U.S. individuals, certain trusts, and estates).
• Added costs: payroll, a separate Form 1120-S, and stricter formalities.

C corporation

• The corporation pays its own tax at a flat 21% federal rate.
• Dividends paid to shareholders are taxed again on their personal returns (double taxation).
• Owners who work in the business can be paid salary, which is deductible to the corporation.
• Potential strengths include retaining after-tax earnings for reinvestment, flexibility for outside investors, and certain employee benefits. The 21% federal corporate rate is only one part of the analysis: state taxes, future distributions, accumulated earnings rules, and the eventual sale must also be considered.

Side-by-side comparison

The benefits of different entity structures have evolved over time. Changing an existing classification has separate tax and legal consequences, especially for a company that has operated under the same classification for years.

When each structure is the best fit

An LLC taxed as a sole proprietorship or partnership often works best when:

• Profits are modest, or the business is just starting.
• You want simplicity and low overhead.
• You own real estate or rental property (partnership or LLC flexibility is valuable, and S corp status can create problems for appreciating property).

An S corporation often works best when:

• The business is profitable enough that the self-employment tax savings clearly exceed the added costs.
• You actively work in the business and can support a defensible salary.
• You expect to take most profit out each year.

A C corporation often works best when:

• You plan to reinvest most profits in the business and the 21% rate beats your personal rate.
• You want outside investors, multiple classes of stock, or foreign owners.
• You may qualify for the Qualified Small Business Stock (QSBS) exclusion under § 1202, which can exclude substantial gain on a sale of qualifying stock held long enough. This can be a major benefit for startups.
• You want the broadest fringe benefits.

Traps to watch out for

• Reasonable compensation. The IRS scrutinizes S corporations that pay owners too little salary. Underpaying invites reclassification of distributions as wages, plus penalties and interest.
• Double taxation and extraction. C corps that retain earnings must watch the accumulated earnings tax. Getting cash out later often triggers a second layer of tax.
• Built-in gains. Converting a C corp to an S corp can expose the business to a corporate-level tax on pre-conversion appreciation.
• Basis and loss limits. S corp and partnership owners can deduct losses only to the extent of basis, at-risk amounts, and passive activity rules.
• State taxes. Some states impose entity-level taxes, franchise taxes, or fees that change the math. Many states also offer pass-through entity tax elections that can help work around the federal SALT limitation.
• Sale of the business. Asset sales and stock sales are taxed very differently depending on entity type. Plan the structure with the exit in mind.
• Changing later. It is usually easier to move from an LLC to an S corp than to unwind a C corp, so consider where the business is heading.

Questions to ask before choosing

• What is my expected net profit this year and over the next three to five years?
• How much cash do I need to take out personally, versus leave in the business?
• Will I seek investors, or plan to sell the business or its stock?
• Do I own real estate or other appreciating assets inside the entity?
• What are my state’s entity-level taxes and fees?
• Am I prepared for payroll and added compliance?

Get advice before you elect

The right structure is a numbers question, and the cost of getting it wrong shows up on audit or at sale. Modeling the options takes into account your income, state, benefits, and growth plans. Contact our office to schedule a consultation and receive a side-by-side comparison for your business.