For tax purposes, most profitable small businesses pick between an LLC taxed as a pass-through, an S-corp election, or a C-corp. The S-corp usually wins once net profit clears roughly $50,000 to $75,000, because only your salary (not your distributions) is subject to payroll taxes. The C-corp fits businesses that reinvest profits or raise outside capital. The plain LLC is the simplest starting point.

This guide walks through how each structure is taxed, where the real savings come from, and how to make the election. It is the pillar of our entity-choice series: companion pieces cover the sole proprietorship conversion framework, S-corp vs LLC for consultants, S-corp election timing, an illustrative S-corp savings example, and reasonable salary rules.

How is an LLC taxed?

An LLC is a state-law structure, not a federal tax category. The IRS applies default rules based on ownership: a single-member LLC is disregarded as separate from its owner (you report the business on Schedule C of your personal return), and a multi-member LLC is taxed as a partnership (Form 1065, with each member receiving a K-1).

In both default cases, the business is a pass-through: profits flow to your personal return and you pay income tax at your individual rates. Critically, the owners also pay self-employment tax on the earnings. The IRS sets self-employment tax at 15.3% of 92.35% of your net earnings (12.4% Social Security up to the annual wage base, 2.9% Medicare on all of it), once you clear $400 of net earnings. For 2026, the Social Security wage base is $184,500. Above $200,000 of self-employment income ($250,000 joint), an additional 0.9% Medicare tax applies.

That 15.3% on every dollar of profit is the number that drives most entity decisions. An LLC can also elect to be taxed as a corporation by filing Form 8832, and from there as an S-corp by filing Form 2553. The LLC gives you liability protection under state law; the tax election decides how the IRS treats you.

How is an S-corp taxed?

An S-corp is also a pass-through: the income is generally taxed to the shareholders rather than to the corporation, and you report it on your personal return via Schedule K-1. There is no entity-level federal income tax in the normal case.

The S-corp's tax advantage is narrower and more specific than people assume. It is not a lower income-tax rate. It is an employment-tax strategy: shareholder-employees must be paid reasonable compensation as W-2 wages before taking non-wage distributions, and only the wages are subject to payroll taxes. Distributions are generally free of Social Security and Medicare tax.

The catch is that "reasonable" is not optional. The IRS has the authority to reclassify distributions as wages (with court cases backing it up), and paying yourself $0 while distributing $150,000 is the classic audit trigger. Our companion piece on reasonable salary rules covers how to benchmark and document your number.

To elect S-corp status, the business must qualify: no more than 100 shareholders, only eligible shareholders (individuals, estates, certain trusts), no nonresident alien shareholders, and one class of stock. The election itself is made on Form 2553.

How is a C-corp taxed?

A C-corp pays tax at the entity level at a flat 21% federal rate (IRC Section 11), then shareholders pay tax again when profits come out as dividends. That double taxation is the reason most small service businesses avoid the C-corp.

The C-corp earns its place in three situations. First, businesses that retain and reinvest most profits can benefit from the 21% rate on money that would otherwise be taxed at a high individual rate. Second, businesses raising outside capital from investors who cannot hold S-corp stock (venture funds, foreign investors, corporations) need the C-corp. Third, certain investor tax benefits, like the qualified small business stock exclusion, only exist in C-corp form. If none of those apply to you, the C-corp is usually the wrong answer.

What is the real tax difference between an LLC and an S-corp?

Put the income-tax treatment aside for a moment: both are pass-throughs, so a dollar of profit faces your individual income-tax rates either way. The difference is entirely in employment taxes, and it works like this:

At $90,000 of net profit, a sole proprietor owes roughly $12,700 in self-employment tax ($90,000 x 92.35% x 15.3%). An S-corp paying a $60,000 reasonable salary owes about $9,200 in combined payroll taxes, and the remaining $30,000 of distributions escapes employment tax entirely. That is the entire game: roughly $3,500 of employment-tax savings in this illustration, before subtracting payroll and compliance costs. We walk through the full math in our illustrative S-corp savings example.

When does the S-corp election start paying off?

The savings are real but the costs are too. An S-corp means running payroll, filing quarterly payroll returns, filing Form 1120-S, and often paying higher state fees and tax-prep bills. Illustrative estimate: budget $1,500 to $3,000 a year for payroll administration and the corporate return combined, depending on your state and provider.

That cost structure is where the widely used $50,000 to $75,000 profit threshold comes from. It is a practitioner rule of thumb, not a line in the tax code: below that range, the payroll and compliance costs typically eat most or all of the employment-tax savings. Above it, the savings scale with profit while the costs stay roughly flat. Our S-corp election timing guide breaks down the decision in detail, including mid-year elections and what happens if you miss the deadline.

How does the 20% QBI deduction change the math?

Section 199A gives eligible pass-through owners a deduction of up to 20% of qualified business income. The 2025 tax legislation (the One Big Beautiful Bill Act) made this deduction permanent instead of letting it expire, which matters for long-term entity planning: the pass-through advantage is now locked in rather than scheduled to sunset.

Two planning notes. First, the deduction applies to LLCs, partnerships, and S-corps alike, so it does not by itself pick a winner. Second, there is a trade-off inside the S-corp: your QBI is generally the K-1 business income, which excludes your W-2 wages, so a higher salary shrinks the QBI base that the 20% applies to. The deduction is subject to income thresholds and other limits, which is exactly the kind of interaction worth modeling before you elect.

What about state taxes?

Federal tax is only half the picture. States impose their own entity costs: formation fees, annual franchise or minimum taxes, and (in many states) entity-level taxes on S-corps and partnerships. Two things to know:

1. PTET elections still work. Most states with an income tax now let pass-through entities elect to pay tax at the entity level, which sidesteps the federal SALT cap for the owners. The 2025 federal legislation preserved these pass-through entity tax workarounds while temporarily raising the individual SALT cap to $40,000 for 2025 through 2029 (it reverts to $10,000 in 2030). If you operate in a high-tax state, the PTET election interacts directly with your entity choice. See our PTET election guide for the full mechanics.

2. State S-corp costs vary widely. Some states tax S-corp income at the entity level or charge meaningful minimum taxes. Model your specific state before electing; the federal savings mean nothing if the state takes them back.

How do you actually make the election?

The mechanics depend on where you are starting:

• Forming a new corporation or LLC and electing S status immediately: file Form 2553. It is due no more than 2 months and 15 days after the beginning of the tax year the election takes effect (March 15 for a calendar-year taxpayer), or at any time during the prior tax year.

• LLC electing corporate status first: file Form 8832, which generally cannot take effect more than 75 days before filing. An LLC that timely files Form 2553 and qualifies is treated as a corporation as of the S election's effective date and does not need a separate Form 8832.

• Missed the deadline: relief is available under Revenue Procedure 2013-30 if you file within 3 years and 75 days of the intended effective date and can show reasonable cause. Late elections are common and routinely fixed, but do not assume; document the intent and act promptly.

One caution: once you revoke or terminate an S election, you generally cannot re-elect for five years without IRS consent (Section 1362(g)). Treat the election as a multi-year commitment, not a toggle you flip annually.

Updated October 14, 2026.

This article is free educational content, not tax advice for your specific situation. If you want a plan built around your actual numbers, that is what our paid tax planning engagements do.