Choosing between an LLC taxed as a sole proprietorship or partnership, an S-corporation, and a C-corporation is one of the first real tax decisions a business owner makes — and one of the most consequential, because it determines how every dollar of profit is taxed for as long as the entity exists in that form.
Default LLC Taxation: Simple, but Full Self-Employment Tax
A single-member LLC is a disregarded entity by default (taxed like a sole proprietorship), and a multi-member LLC is taxed as a partnership by default — in both cases, all net profit flows to the owner’s personal return and is subject to the full 15.3% self-employment tax, with no distinction between “salary” and “profit.” It’s the simplest structure to run, but it’s also the one that leaves the most self-employment tax on the table once profits grow.
S-Corp Election: Splits Pay Into Salary and Distribution
Electing S-corp status (either by having the LLC file Form 2553, or incorporating directly as a corporation and electing S status) lets the owner take a reasonable salary subject to payroll tax, then take remaining profit as a distribution that isn’t subject to self-employment tax at all. The tradeoff is real administrative cost: running payroll, filing a separate Form 1120-S, and defending the “reasonable salary” figure against IRS scrutiny. Most CPAs put the breakeven point where the self-employment tax savings start to outweigh the added compliance cost somewhere around $40,000–$50,000 of profit after a reasonable salary is paid.
C-Corp: Double Taxation, But a Different Set of Advantages
A C-corp pays its own 21% flat corporate tax rate, and then shareholders pay tax again (at 0%–23.8% depending on income) when profit is distributed as a dividend — the classic “double taxation” problem. But a C-corp is the only structure eligible for Section 1202 Qualified Small Business Stock treatment, which can exclude up to $15 million in gain on a future sale, and it’s the structure venture investors generally require before writing a check. For a business planning to raise institutional capital or aiming for a large equity exit, the double-taxation cost can be worth it for the QSBS benefit alone.
The QBI Deduction Cuts Across All of Them, With One Catch
The 20% Qualified Business Income deduction under Section 199A, made permanent by OBBBA, is available to sole proprietorships, partnerships, and S-corps (not C-corps) — but it only applies to the pass-through profit, not to S-corp W-2 salary. That’s a real, easy-to-miss detail: paying yourself a larger S-corp salary reduces self-employment tax exposure on that portion, but it also shrinks the QBI-eligible income the deduction is calculated on, which is why the salary number in an S-corp needs to be optimized against both effects together, not just against payroll tax.
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Related reading: S-Corp Reasonable Compensation and QSBS Section 1202.
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