When structuring a business, choosing the right tax designation can impact your tax liability, compliance obligations, and long-term financial benefits. Two of the most common options are LLC taxation (default) and S-Corporation (S-Corp) taxation (an election made by an LLC or corporation).
S-Corp Taxation
An S-Corporation (S-Corp) is not a business entity but a tax designation that LLCs or corporations can elect with the IRS. S-Corp taxation allows businesses to avoid self-employment taxes on some of their profits while still benefiting from pass-through taxation.
- Business profits pass through to the owner’s personal tax return, avoiding double taxation.
- Owners must pay themselves a “reasonable salary” (subject to payroll taxes) before taking distributions, which are not subject to self-employment tax.
- S-Corps have stricter rules, including ownership restrictions (only U.S. citizens/residents and a limit of 100 shareholders).
LLC Taxation
A Limited Liability Company (LLC) is a business structure that provides legal protection and flexibility. By default, an LLC is taxed as a sole proprietorship (single-member LLC) or a partnership (multi-member LLC). However, LLCs can also elect to be taxed as an S-Corp or C-Corp if beneficial.
- Profits and losses pass through to the owner’s personal tax return, avoiding corporate-level taxes.
- Owners pay self-employment tax (15.3%) on all net income.
- LLCs offer fewer compliance requirements and more ownership flexibility than S-Corps.
Pros and Cons to each
Pros of S-Corp Taxation
- Self-Employment Tax Savings – Owners only pay payroll taxes on their salary, not on profit distributions.
- Pass-Through Taxation – Business income is reported on the owner’s tax return, avoiding double taxation.
- Business Credibility – S-Corps are seen as more structured and professional, which can help secure loans or attract investors.
Cons of S-Corp Taxation
- Strict IRS Rules – Owners must take a reasonable salary before taking distributions, or they risk IRS penalties.
- Increased Paperwork – S-Corps require payroll processing, corporate bylaws, and regular meetings.
- Ownership Restrictions – Limited to 100 shareholders and only U.S. citizens/residents can be owners.
Pros of LLC Taxation
- Simplicity – Fewer IRS regulations, no required salary, and minimal paperwork.
- Flexibility – Owners can distribute profits in any manner and add multiple members easily.
- Lower Administrative Costs – No need for payroll processing unless electing S-Corp status.
Cons of LLC Taxation
- Higher Self-Employment Taxes – Owners pay 15.3% self-employment tax on all profits.
- Less Tax Planning Flexibility – Unlike an S-Corp, LLCs can’t classify part of income as distributions to reduce tax liability.
- Potential for Higher State Taxes – Some states impose franchise taxes or additional fees on LLCs.
Why an LLC might be right for you
An LLC is a great option for small business owners, freelancers, and entrepreneurs who want:
- Simplicity – If you don’t want the hassle of corporate compliance, an LLC is easier to manage.
- Flexibility – LLCs can have multiple owners, distribute profits however they want, and easily convert to an S-Corp later.
- Legal Protection – Provides a legal shield, protecting personal assets from business debts and lawsuits.
- Lower Administrative Costs – No need to run payroll unless electing S-Corp status, saving time and money.
Who Benefits from an LLC?
- Solo entrepreneurs and freelancers – Simple structure, minimal taxes, and liability protection.
- Side business owners – If you run a business part-time and want to limit risk without a complicated setup.
- Small businesses with no employees – No payroll requirements unless electing S-Corp status.
- Partnerships – An LLC allows multiple owners while keeping liability protection and tax simplicity.
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