S-Corp vs C-Corp vs LLC: Which Entity Structure Saves You the Most in Taxes
Your entity structure determines how every dollar of profit is taxed. The wrong choice costs tens of thousands per year.
Why Entity Structure Matters
Entity structure is not a legal formality -- it is the single decision that determines the tax treatment of every dollar your business earns. An LLC taxed as a sole proprietorship pays self-employment tax on all net income. The same business electing S-Corp status splits income between salary and distributions, potentially saving $20,000 to $40,000 per year.
How an LLC Is Taxed by Default
A single-member LLC is a disregarded entity for federal tax purposes. All income flows through to your personal Form 1040 on Schedule C. You pay ordinary income tax plus self-employment tax of 15.3% on the first $168,600 and 2.9% Medicare on everything above that. For businesses earning under $60,000 to $80,000, the compliance cost of an S-Corp election often exceeds the savings.
How an S-Corp Is Taxed
S-Corp shareholders who work in the business must pay themselves a reasonable salary through payroll, but remaining profit distributed as shareholder distributions is not subject to self-employment tax. If your business nets $300,000 and reasonable compensation is $120,000, the remaining $180,000 avoids the 15.3% SE tax, saving roughly $27,000 per year. S-Corp income is generally eligible for the 20% QBI deduction under Section 199A.
How a C-Corp Is Taxed
A C-Corp is taxed at a flat 21% federal rate. Profits distributed as dividends are taxed again at the shareholder level. If you retain earnings and reinvest them, there is no second layer of tax until distribution. C-Corps unlock fringe benefits not available to S-Corp shareholders owning more than 2%: health insurance, group term life, educational assistance, and dependent care under IRC Sections 79, 105, 106, 127, and 129.
Side-by-Side at $400,000 Net Income
LLC: Total tax roughly $89,800. S-Corp ($150K salary): Total roughly $73,350 -- $16,450 less. C-Corp retaining $250K: Total approximately $93,450 in year one, but effective rate on retained earnings is only 21% and Section 1202 QSBS can eliminate up to $10M of gain on future sale.
When to Elect S-Corp Status
The S-Corp election makes sense when your business consistently generates net income above $80,000 to $100,000. File Form 2553 by March 15. An existing LLC simply files Form 2553 and elects S-Corp treatment while remaining an LLC under state law.
When a C-Corp Strategy Works Better
C-Corp strategies outperform when the business retains substantial profits, when the owner needs tax-free fringe benefits, or when the business qualifies for the Section 1202 QSBS exclusion. If you hold C-Corp stock for more than five years and the corporation has gross assets under $50 million, up to $10 million of gain can be excluded from federal income tax entirely.
Key Takeaways
- LLCs pay SE tax on all net earnings, making them expensive above $80K-$100K in profit.
- S-Corp elections save $15,000-$40,000/year by eliminating SE tax on distributions.
- C-Corps tax retained earnings at 21% and unlock tax-free fringe benefits.
- Section 1202 QSBS exclusion can eliminate tax on up to $10M of gain.
Frequently Asked Questions
At what income level should I elect S-Corp status?
The breakeven is typically $80,000 to $100,000 in net business income. Above $150,000, the S-Corp savings are substantial.
Can I switch from S-Corp to C-Corp?
Yes. File a statement of revocation signed by shareholders holding more than 50% of the stock. Once revoked, you cannot re-elect for five years.
Does a C-Corp always mean double taxation?
No. Double taxation only occurs on distributed dividends. Retained earnings, salary, and Section 1202 sales can eliminate the second layer.
What is reasonable compensation?
The amount you would pay someone with your skills and responsibilities to do your work. Setting it too low is the top S-Corp audit trigger.
Can I have both an S-Corp and a C-Corp?
Yes. Many owners use an S-Corp for operations and a C-Corp management company to shift income into the 21% bracket.
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