Choosing the Right Business Entity: LLC vs. S-Corp for Tax Purposes

The short version

This is one of the most common questions we get from growing businesses, and it's a good one to ask, because the entity you choose affects how much you pay in taxes every single year.

An LLC is a legal structure. An S-Corp is a tax election. You can actually be an LLC that elects to be taxed as an S-Corp, which is exactly what a lot of profitable small businesses end up doing.

How an LLC is taxed by default

By default, a single-member LLC is taxed as a sole proprietorship, and a multi-member LLC is taxed as a partnership. In both cases, profits pass through to your personal tax return, and you pay self-employment tax on all of it. That's the part that catches people off guard. Every dollar of profit is subject to that tax, not just what you pay yourself.

How an S-Corp changes the math

With an S-Corp election, you pay yourself a reasonable salary through payroll, and that salary is subject to payroll taxes. Anything left over after salary can be taken as a distribution, which isn't subject to self-employment tax. That split is where the savings come from.

Here's a simplified, illustrative example, not a quote for any specific business. Say a business nets $120,000 in profit. As a sole proprietor, self-employment tax alone runs into the tens of thousands. As an S-Corp, if the owner pays themselves a reasonable salary and takes the remainder as a distribution, only the salary portion is subject to payroll tax. Depending on the situation, that split can mean real savings.

Where it gets complicated

The IRS requires that S-Corp owners pay themselves a reasonable salary, meaning what someone in a similar role would typically earn. Pay yourself too little relative to your distributions, and you're inviting IRS scrutiny. This is the number one mistake we see business owners make when they try to set this up on their own.

There's also added complexity: S-Corps require running payroll, filing an additional tax return, and generally more bookkeeping discipline than a straightforward LLC.

When it makes sense to switch

As a general rule of thumb, the S-Corp election tends to start making financial sense once a business is consistently profitable, though the exact break-even point depends on your state, your industry, and your specific numbers, not a single dollar figure. Below a certain profitability level, the added administrative cost and complexity often isn't worth the tax savings.

This isn't a decision to make alone

The right structure depends on your specific numbers, your industry, and your growth plans. Getting it wrong in either direction, staying a sole proprietor too long or electing S-Corp status prematurely, costs money either way. This is exactly the kind of decision proactive tax planning is built to work through with real numbers instead of a rule of thumb.

If you're not sure where your business stands, request a financial assessment and we'll run the actual numbers for your situation.