LLC vs S‑Corp vs C‑Corp: Which Structure Saves You the Most on Taxes?
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Quick overview
Entity choice affects how profits are taxed, how you pay yourself, compliance workload, and opportunities for tax planning.
LLC taxation
- Default pass‑through: Income passes to owners and is taxed on their returns.
- Self‑employment tax: Active members generally pay SE tax on business profits.
- Flexible elections: An LLC can elect S‑Corp or C‑Corp treatment for tax.
Tip: Single‑member LLCs are disregarded for tax by default, but still provide legal separation under state law.
S‑Corp advantages & requirements
- Salary + distributions: Owners on payroll take a reasonable salary; remaining profits may avoid SE tax.
- Eligibility: U.S. entity, 100 or fewer shareholders, one class of stock, individuals/qualifying trusts as owners.
- Compliance: Payroll, officer compensation, and annual S‑Corp return.
C‑Corp pros & cons
- Flat corporate rate: Profits taxed at the corporate level.
- Double taxation risk: Dividends taxed again to shareholders.
- Planning levers: Retain earnings, employee benefits, equity incentives.
Side‑by‑side comparison
| Feature | LLC (default) | S‑Corp | C‑Corp |
|---|
| Taxation | Pass‑through | Pass‑through | Corporate |
| Self‑employment tax | Yes (active) | On salary only | No (but payroll taxes on wages) |
| Owner pay | Draws | Salary + distributions | Salary + dividends |
| Admin burden | Low | Medium (payroll) | Medium/High |
How to decide
- Estimate profits and your target salary.
- Model payroll taxes vs. SE tax.
- Consider future funding, equity, and exit plans.
Understanding Pass‑Through Taxation for LLCs and S‑Corps
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What is pass‑through taxation?
Business profits “pass through” to owners, who pay tax at individual rates. The business generally does not pay an entity‑level income tax.
Schedule K‑1 & owner reporting
Owners receive a K‑1 showing their share of income, deductions, credits, and other items to report on their personal returns.
Self‑employment & payroll taxes
- LLC members typically owe self‑employment tax on active income.
- S‑Corp owners on payroll pay FICA on wages; distributions are not subject to SE tax.
The Qualified Business Income (QBI) deduction
Many pass‑through owners may qualify for a deduction on qualified business income, subject to thresholds and limitations.
How Business Structure Affects Your Personal Tax Liability
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How income flows to you
- Sole prop/LLC (default): Report on Schedule C; net profit subject to income and self‑employment tax.
- S‑Corp: W‑2 wages + K‑1 pass‑through; distributions typically not subject to SE tax.
- C‑Corp: W‑2 wages; dividends taxed to you separately.
Compensation mechanics
Reasonable compensation for S‑Corp owners is essential. C‑Corps allow broader fringe benefits but may trigger double taxation on dividends.
Deductions, credits, and phase‑outs
Your filing status, total income, and business type influence eligibility for deductions and credits, including the QBI deduction and retirement contributions.
Planning scenarios
- High‑profit service business: Consider S‑Corp election for payroll vs. distributions.
- Reinvesting capital: A C‑Corp may help retain earnings for growth.
- Flexible ownership: Multi‑member LLC with tailored allocations via operating agreement.
How to Switch from Sole Proprietor to an LLC for Better Tax Benefits
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Why switch
- Limited liability protection
- Cleaner owner compensation options
- Path to S‑Corp or C‑Corp tax treatment later
Formation steps
- Choose a state and name, file Articles of Organization.
- Draft an Operating Agreement.
- Designate a registered agent.
- Obtain required licenses.
EIN, bank & bookkeeping
Apply for a new EIN, open a dedicated business bank account, and update your accounting system to reflect the new entity.
Optional S‑Corp election
When profits and owner involvement justify payroll, consider electing S‑Corp status and setting a reasonable salary.
Transition checklist
- Update contracts and vendor accounts to the LLC.
- Notify clients and update invoices.
- Close sole prop permits if required.
Incorporating in Another State: Is It Really Worth It for Tax Savings?
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The “tax haven” myth for small businesses
Most small businesses owe tax where they actually operate and earn income, regardless of formation state.
Nexus & doing business where you operate
Physical presence, employees, or significant sales typically create filing obligations in those states.
Fees, registered agents, & double filings
Out‑of‑state formations often mean you’ll register as a foreign entity in your home state and pay fees in both places.
When out‑of‑state can make sense
- Multi‑state operations with investors who prefer specific corporate law.
- Planned venture funding or complex equity structures.
- Specialized statutes or courts (e.g., chancery‑style) when growth justifies complexity.