Entity choice affects taxes. LLCs taxed differently. S-Corps taxed differently. C-Corps taxed differently.
Most owners choose entity without understanding tax impact. They make expensive mistakes. They pay more than necessary.
Entity structure determines tax treatment. Understanding differences saves money. It enables strategy.
This guide shows how LLC vs. S-Corp vs. C-Corp affects your tax bill.
Key Takeaways
- Understand differences—learn tax treatment
- Compare structures—see tax impact
- Choose strategically—select best structure
- Plan taxes—optimize tax strategy
- Save money—reduce tax burden
Table of Contents
Entity Tax Overview
Entity structure determines tax treatment. Each structure has different rules. Each affects your tax bill.
LLCs have flexibility: Pass-through taxation. Self-employment taxes. Flexible structure.
S-Corps have benefits: Pass-through taxation. Potential self-employment tax savings. Ownership restrictions.
C-Corps have complexity: Corporate taxation. Double taxation risk. More complexity.
Why this matters: Entity understanding enables strategy. If you understand entity, strategy improves.
LLC Taxation
LLCs use pass-through taxation. Income passes to owners. Owners pay taxes.
How LLCs Are Taxed
Pass-through structure:
- Business income passes to owners
- Owners report on personal returns
- No corporate tax
- Self-employment taxes apply
Why this matters: Pass-through taxation affects tax bill. If you understand pass-through, tax bill becomes clear.
Self-Employment Taxes
Self-employment tax applies:
- On all business income
- Social Security and Medicare
- Higher rate than W-2
- No employer match
Why this matters: Self-employment taxes increase cost. If you understand self-employment taxes, cost becomes clear.
Tax Flexibility
LLCs offer flexibility:
- Can elect S-Corp status
- Can elect C-Corp status
- Can remain pass-through
- Options exist
Why this matters: Flexibility enables strategy. If you have flexibility, strategy becomes possible.
Pro tip: Use our TAM Calculator to evaluate market opportunity and inform business planning. Calculate market size to understand growth potential.
S-Corp Taxation
S-Corps use pass-through taxation with potential savings. Income passes to owners. Self-employment tax savings possible.
How S-Corps Are Taxed
Pass-through structure:
- Business income passes to owners
- Owners report on personal returns
- No corporate tax
- Salary vs. distribution split
Why this matters: Pass-through taxation affects tax bill. If you understand pass-through, tax bill becomes clear.
Self-Employment Tax Savings
Potential savings:
- Salary subject to self-employment tax
- Distributions not subject to self-employment tax
- Reasonable salary required
- Savings depend on split
Why this matters: Self-employment tax savings reduce cost. If you understand savings, cost decreases.
Ownership Restrictions
S-Corp limitations:
- Limited number of owners
- Limited owner types
- No corporate owners
- Restrictions apply
Why this matters: Ownership restrictions limit flexibility. If you understand restrictions, flexibility becomes clear.
C-Corp Taxation
C-Corps use corporate taxation. Business pays corporate tax. Owners pay personal tax on distributions.
How C-Corps Are Taxed
Corporate taxation:
- Business pays corporate income tax
- Owners pay personal tax on distributions
- Double taxation risk
- Corporate tax rate applies
Why this matters: Corporate taxation affects tax bill. If you understand corporate taxation, tax bill becomes clear.
Double Taxation
Double taxation occurs:
- Corporate income taxed at corporate rate
- Distributions taxed at personal rate
- Total tax higher
- Planning can reduce
Why this matters: Double taxation increases cost. If you understand double taxation, cost becomes clear.
Tax Planning Opportunities
Planning opportunities exist:
- Retained earnings strategies
- Salary vs. distribution planning
- Corporate tax deductions
- Long-term planning
Why this matters: Planning opportunities reduce taxes. If you understand opportunities, taxes decrease.
Comparison
Quick comparison of tax treatment:
| Aspect | LLC | S-Corp | C-Corp |
|---|---|---|---|
| Tax Structure | Pass-through | Pass-through | Corporate |
| Self-Employment Tax | On all income | On salary only | On salary only |
| Corporate Tax | No | No | Yes |
| Double Taxation | No | No | Yes |
| Flexibility | High | Medium | Low |
Why this matters: Comparison enables decisions. If you compare structures, decisions improve.
Pro tip: Use our TAM Calculator to evaluate market opportunity and inform business planning. Calculate market size to understand growth potential.
Your Next Steps
Entity tax strategy affects your tax bill. Understand differences, compare structures, choose strategically, plan taxes, then save money to reduce tax burden.
This Week:
- Begin understanding entity tax differences using our TAM Calculator
- Start comparing structures
- Begin evaluating your situation
- Start planning tax strategy
This Month:
- Complete understanding of differences
- Compare all structures
- Evaluate your situation
- Develop tax strategy
Going Forward:
- Continuously evaluate structure
- Plan taxes strategically
- Optimize tax strategy
- Save money
Need help? Check out our TAM Calculator for market evaluation, our tax basics guide for fundamentals, our tax strategy hub for tactics, and our working with tax pro guide for professionals.
Stay informed about business strategies and tools by following us on X (Twitter) and signing up for The Initiative Newsletter.
FAQs - Frequently Asked Questions About Entity and Tax Strategy: How LLC vs. S‑Corp vs. C‑Corp Affects Your Bill
How does an LLC's pass-through taxation work and affect my tax bill?
LLC profits pass directly to you as the owner, you report them on your personal tax return, and you pay self-employment taxes (Social Security and Medicare) on all business income.
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With an LLC's default pass-through structure, the business itself doesn't pay federal income tax. Instead, all profits flow through to your personal tax return where they're taxed at your individual income tax rate. This avoids the double taxation that C-Corps face.
The catch is self-employment tax. As an LLC owner, you pay 15.3% in self-employment taxes (12.4% Social Security plus 2.9% Medicare) on all net business income. This applies to every dollar of profit, which can add up significantly as your business grows. LLCs do offer flexibility—you can later elect S-Corp or C-Corp tax treatment without changing your legal structure.
How does S-Corp tax treatment save money on self-employment taxes?
S-Corp owners split income between a reasonable salary (subject to employment taxes) and distributions (not subject to employment taxes), saving on the distribution portion.
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An S-Corp uses the same pass-through structure as an LLC—no corporate-level tax. The key difference is how self-employment taxes work. As an S-Corp owner-employee, you pay yourself a 'reasonable salary' that's subject to payroll taxes (the equivalent of self-employment tax). But any profit above that salary can be taken as distributions, which are not subject to Social Security and Medicare taxes.
For example, if your business earns $150,000 and you pay yourself a $70,000 salary, only the $70,000 is subject to employment taxes. The remaining $80,000 in distributions avoids the 15.3% self-employment tax, potentially saving you over $12,000. The IRS requires that the salary be 'reasonable' for your role—you can't pay yourself a token salary to maximize distributions.
What is double taxation in a C-Corp and when does it actually matter?
Double taxation means the corporation pays tax on profits at the corporate rate, and shareholders pay personal tax again when those profits are distributed as dividends.
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In a C-Corp, the business pays a flat 21% federal corporate income tax on its profits. When those after-tax profits are distributed to shareholders as dividends, the shareholders pay personal income tax on the dividends—typically at the qualified dividend rate of 0%, 15%, or 20% depending on their income bracket.
Double taxation matters most when you plan to distribute profits regularly. If the business retains earnings for growth, reinvestment, or future expansion, the immediate impact is lower because no dividends trigger the second layer of tax. C-Corps can also reduce taxable income through salaries, benefits, and deductions, which is why strategic tax planning can mitigate the double taxation concern significantly.
When should I elect S-Corp tax status for my LLC instead of keeping default pass-through treatment?
When your net business profits are consistently high enough that the self-employment tax savings on distributions exceed the added costs of payroll administration and tax preparation.
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The general threshold is when your business consistently nets enough profit that splitting between salary and distributions creates meaningful savings. If you're earning $40,000 in profit, the savings may not justify the added complexity. At $80,000-$100,000 and above, the math often works in your favor.
Before electing, calculate the full cost: you'll need to run payroll (monthly or bi-weekly), pay payroll service fees, file additional tax returns (Form 1120-S), and potentially increase your accounting costs. If the self-employment tax savings on distributions exceed these costs by a comfortable margin, S-Corp election makes sense. Consult a CPA with your actual numbers before making the election.
Which entity type offers the most tax flexibility for a new business?
An LLC offers the most flexibility because it can be taxed as a sole proprietorship, partnership, S-Corp, or C-Corp without changing its legal structure.
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LLCs are uniquely flexible. By default, a single-member LLC is taxed as a sole proprietorship and a multi-member LLC as a partnership—both pass-through. But you can file IRS Form 2553 to elect S-Corp tax treatment, or Form 8832 to elect C-Corp treatment, all while keeping your LLC legal structure intact.
This flexibility lets you start simple with default pass-through taxation when your business is young, then switch to S-Corp treatment when profits justify the complexity, and potentially move to C-Corp treatment if you take on venture capital or plan to go public. You're never locked into one tax structure, which is a significant advantage over forming a corporation from the start.
How do ownership restrictions differ between S-Corps and C-Corps, and why does it matter?
S-Corps limit you to 100 shareholders who must be U.S. citizens or residents, while C-Corps have no ownership restrictions—any number and type of shareholder is allowed.
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S-Corp restrictions are significant: maximum of 100 shareholders, all must be U.S. citizens or resident aliens, no corporate or partnership shareholders allowed, and only one class of stock permitted. These rules prevent many business arrangements, especially those involving foreign investors, venture capital firms, or complex equity structures.
C-Corps face none of these limitations. They can have unlimited shareholders of any type—individuals, other corporations, partnerships, trusts, foreign investors—and can issue multiple classes of stock (common and preferred). This is why venture-backed startups almost always use C-Corp structure: investors need preferred stock with specific rights, and many investors are entities that can't hold S-Corp shares.
Sources & Additional Information
This guide provides general information about entity tax strategy. Your specific situation may require different considerations.
For market size analysis, see our TAM Calculator.
Consult with professionals for advice specific to your situation.
