Guides · Business structures

LLC vs S-Corp vs sole proprietor — which structure for tax

The structure you choose for a one-owner business affects how the profits are taxed. Sole proprietorship and single-member LLC (default tax treatment) pass profits through to Schedule C, where they are taxed at ordinary rates plus 15.3% self-employment tax. S-corporation election reduces self-employment tax on the owner's salary and treats the remaining profits as a distribution — saving up to $20,000/year in self-employment tax. C-corporation is the wrong choice for most small businesses — double taxation makes it expensive.

The four structures

For a one-owner business, the practical choice is between:

Sole proprietorship — unincorporated; you and the business are the same legal entity.
Single-member LLC — limited liability company owned by one person. For tax purposes, the IRS treats a single-member LLC as a sole proprietorship by default (unless you elect otherwise).
S-corporation — a federal tax election (Form 2553) that lets profits pass through to the owner's personal return while limiting self-employment tax.
C-corporation — a separately-taxed corporation. Profits are taxed at the corporate level, then dividends to the owner are taxed again. Generally the wrong choice for small businesses.

The choice has legal consequences (liability protection, ability to raise venture capital, succession planning) and tax consequences (how profits are taxed, what forms you file). This guide focuses on tax.

Sole proprietorship / single-member LLC

The default structure. Profits pass through Schedule C:

Federal income tax on net profit at ordinary rates (10-37%).
Self-employment tax (15.3%) on net earnings up to the Social Security wage base ($184,500 in 2026), plus 2.9% Medicare on all net earnings.
Half of self-employment tax is deductible "above the line" for income tax purposes.
Quarterly estimated payments via Form 1040-ES.
No separate entity-level return; everything on the owner's Form 1040.

Worked example: sole proprietor earning $150,000 net profit in 2026:

Self-employment tax: $184,500 cap irrelevant (under $184,500); 15.3% × $150,000 = $22,950.
Half-SE-tax deduction: $11,475 above the line.
Adjusted gross income (assuming no other income): $150,000 - $11,475 = $138,525.
Standard deduction: $16,100.
Taxable income: $122,425.
Federal income tax: $10,365 (10/12/22/24% brackets).
Combined federal tax: $22,950 + $10,365 = $33,315 (22.2% effective rate, not counting QBI deduction).

The QBI deduction (Section 199A) lets a sole proprietor deduct up to 20% of qualified business income. For 2026, the threshold for the phase-out is taxable income of $241,950 (single) / $483,900 (MFJ). Above that, the deduction phases out for specified service trades (SSTBs) like law, consulting, health.

S-corporation

An S-corp is a federal tax election (Form 2553) that lets the corporation's profits pass through to the owner's personal return. The advantage: profits above a "reasonable salary" paid to the owner are not subject to self-employment tax.

Same example, now as an S-corp with $150,000 net profit and a $80,000 salary to the owner:

Salary: $80,000 — subject to federal income tax (W-2), Social Security (6.2% × $80,000 = $4,960), Medicare (1.45% × $80,000 = $1,160). Total employment tax: $6,120.
Distribution: $70,000 ($150,000 - $80,000) — subject to federal income tax only (no self-employment tax).
Owner's adjusted gross income: $80,000 salary + $70,000 distribution = $150,000.
Standard deduction: $16,100.
Taxable income: $133,900.
Federal income tax: $11,700 (approximately).
Combined: $6,120 + $11,700 = $17,820.

Compared to the sole proprietor:

Sole prop total tax: $33,315.
S-corp total tax: $17,820.
Savings: $15,495 — about 10% of the $150,000 profit.

The savings come from the $70,000 of "distribution" avoiding the 15.3% self-employment tax. The savings increase with higher profits (more distribution, same SE tax avoidance) but shrink at lower profits (less salary, less room to classify as distribution).

Reasonable compensation requirement

The S-corp salary must be "reasonable" for the work performed. The IRS scrutinizes this — owners who pay themselves $1 in salary and take $149,000 in distribution are flagged. Reasonable compensation is industry-specific; for a $150,000-profit business, a salary of $60,000-$100,000 is usually defensible, depending on the role.

QBI deduction for S-corp

The 20% QBI deduction still applies to S-corp pass-through income, but the calculation includes both salary and distribution. Combined with the SE tax savings, QBI is the second leg of the S-corp advantage.

C-corporation

A C-corp is a separately-taxed entity. Profits are taxed at the corporate level first (21% federal rate for 2026), and dividends to the owner are taxed again at the owner's personal rate (15-20% long-term qualified dividend rate for most owners).

The combined effective rate on $150,000 of profit:

Corporate tax: $150,000 × 21% = $31,500.
After-tax profit: $118,500.
Dividend (assuming all paid out): $118,500.
Qualified dividend tax (15% bracket): $17,775.
Net to owner: $100,725.
Effective rate: $49,275 / $150,000 = 32.9%.

C-corp is 13-15 percentage points worse than S-corp for the same $150,000 profit. The structure makes sense for:

Companies that plan to raise venture capital or sell equity (venture-grade investors generally require C-corp).
Companies that want to retain earnings in the business for reinvestment (corporate tax rate is lower than individual rate at high incomes).
Multinational operations that benefit from international tax treaties.
Public companies (no other choice).

For one-owner small businesses, partnerships, and most professional services, C-corp is the wrong choice.

Side-by-side comparison

US business structures — tax comparison at $150k profit
Item	Sole prop / SMLLC	S-corp	C-corp
Total federal tax (15.3% SE on all)	$33,315	$17,820	$49,275
Effective rate	22.2%	11.9%	32.9%
Forms required	Schedule C, Form 1040	1120-S, K-1, 1040	1120, dividend 1099-DIV, 1040
Payroll needed?	No	Yes (for salary)	Yes (for salary)
Liability protection	Yes (LLC) / No (sole prop)	Yes	Yes

QBI deduction (Section 199A)

The Qualified Business Income deduction lets pass-through owners (sole prop, partnership, S-corp) deduct up to 20% of qualified business income. Available 2018-2025 under TCJA; extended under the One Big Beautiful Bill Act (OBBBA) with some modifications through 2033.

For 2026:

Taxable income below threshold ($241,950 single / $483,900 MFJ): full 20% deduction.
Above threshold: phase-out for SSTBs (specified service trades — law, accounting, consulting, health, financial services, athletics).
Non-SSTBs: full deduction if W-2 wages paid and unadjusted basis immediately after acquisition (UBIA) of qualified property exceed thresholds.

The QBI deduction reduces taxable income but not self-employment tax. Combined with an S-corp election, the savings stack:

S-corp: ~$15,000 in self-employment tax savings.
QBI: up to 20% of the remaining taxable income deducted.

Reasonable compensation

The IRS's Rev. Rul. 74-44 and subsequent guidance establish factors for "reasonable compensation" for S-corp owner-employees:

Training and experience.
Duties and responsibilities.
Time and effort devoted to the business.
Dividend history.
Payments to non-shareholder employees.
Timing and manner of payments.
Use of a formula to determine compensation.
Comparable compensation in similar businesses.

Resources for benchmarking reasonable compensation:

BLS Occupational Employment and Wage Statistics (OEWS).
Robert Half Salary Guide.
SHRM compensation data.
Industry-specific compensation surveys.

Document the reasoning: keep a memo showing what comparable professionals earn, what the owner's role entails, and why the chosen salary is reasonable. This becomes important if the IRS audits.

When to elect S-corp

The breakeven calculation:

For an S-corp election to save money, the salary must be less than the total net profit (otherwise the savings on the distribution are zero). A rough rule of thumb: net profit above $40,000-$50,000 is often the threshold for S-corp savings to exceed the additional compliance costs (separate payroll, separate 1120-S return, additional accounting fees).

Considerations:

Below $30k net profit: stick with sole prop or single-member LLC. S-corp compliance costs ($1,500-$3,000/year in additional fees) outweigh savings.
$30k-$80k net profit: borderline; consider the breakeven calculation. A CPA can run the numbers.
$80k+ net profit: S-corp almost always wins.

Election deadline: Form 2553 must be filed by the 15th day of the 3rd month of the tax year the election takes effect (March 15 for a calendar-year S-corp). Late election relief is available for inadvertent invalid elections but requires a private letter ruling (user fee ~$12,000 in 2026).