Choosing the right business structure is one of the most important tax decisions you will make as a business owner.
Whether you are just starting out or already generating a steady income, the way your business is structured can significantly affect how much tax you pay each year.
LLCs, S-Corps, and C-Corps are the most common business entities in the United States.
On the surface, they may seem similar.
They all allow you to operate a business, earn income, and protect yourself from personal liability in most cases.
The difference lies in how they are taxed.
Two businesses with the same profit can end up with very different tax bills simply because they chose different structures.
One owner may pay large self-employment taxes. Another may reduce payroll taxes through an S-Corp election. A third may pay corporate tax and then personal tax on dividends.
This is where confusion often starts.
Many business owners choose an entity based on what they hear from friends, social media, or online forums. Others stick with the structure they started with and never revisit it as income grows. Both approaches can lead to unnecessary tax costs.
In this article, you will learn how LLCs, S-Corps, and C-Corps are taxed, how owner compensation works in each structure, and how taxes compare side by side.
What Is an LLC?
An LLC, or Limited Liability Company, is a flexible business structure created at the state level. It is popular because it is simple to set up and easy to maintain.
From a legal perspective, an LLC provides liability protection. This means your personal assets are usually protected if the business is sued or cannot pay its debts.
From a tax perspective, an LLC is flexible. The IRS does not have a specific tax category called “LLC.” Instead, an LLC chooses how it wants to be taxed. By default:
- A single-member LLC is taxed like a sole proprietorship
- A multi-member LLC is taxed like a partnership
An LLC can also elect to be taxed as an S-Corporation or a C-Corporation if it meets the requirements.
This flexibility is one of the main reasons LLCs are so common.
What Is an S-Corporation?
An S-Corporation is not a type of company you form at the state level in most cases.
It is a tax election made with the IRS.
Many S-Corps start as LLCs or regular corporations and then file an election to be taxed under Subchapter S of the tax code.
The key feature of an S-Corp is pass-through taxation.
This means the business itself does not pay federal income tax. Instead, profits pass through to the owners and are reported on their personal tax returns.
S-Corps are popular with profitable small businesses because they can reduce self-employment taxes when structured correctly.
However, they come with more rules, including limits on who can own shares and how owners are paid.
What Is a C-Corporation?
A C-Corporation is a separate legal and tax entity. It is the default type of corporation under the tax code.
Unlike LLCs and S-Corps, a C-Corp pays its own federal income tax on profits. Owners then pay personal tax again when profits are distributed as dividends. This is commonly referred to as double taxation.
Despite this, C-Corps can make sense in certain situations. They are often used by venture-backed startups, companies planning to reinvest profits, or businesses that want to offer multiple classes of stock.
C-Corporations are subject to a flat federal corporate tax rate, which is set by law.
How LLCs Are Taxed
LLCs are popular because they offer flexibility, especially when it comes to taxes.
The way your LLC is taxed depends on how many owners it has and whether you make a special election with the IRS.
Default Taxation of Single-Member LLCs
If you own a single-member LLC and do not make any special tax election, the IRS treats your business as a disregarded entity.
This means:
- The LLC does not file a separate federal income tax return
- Business income and expenses are reported on Schedule C of your personal tax return
- Profits are taxed at your personal income tax rate
You report the net profit from the business on your Form 1040. While this approach is simple, it comes with an important downside. All net profit is subject to self-employment tax.
The IRS explains single-member LLC taxation.
Default Taxation of Multi-Member LLCs
If your LLC has two or more owners and you do not make a tax election, the IRS treats it as a partnership.
In this case:
- The LLC files an informational return, Form 1065
- Each owner receives a Schedule K-1
- Profits and losses pass through to the owners’ personal tax returns
Each owner reports their share of income, even if the money stays in the business. This is known as pass-through taxation.
Like single-member LLCs, partnership income is generally subject to self-employment tax for active owners.
You can review partnership tax rules on the IRS website.
Self-Employment Tax Impact
Self-employment tax is one of the biggest tax costs for LLC owners.
It covers:
- Social Security tax
- Medicare tax
The combined rate is 15.3 percent on net earnings up to the Social Security wage base, with additional Medicare tax at higher income levels.
This means if your LLC earns $100,000 in net profit, you may owe over $15,000 in self-employment taxes alone, on top of income tax.
As your income grows, this tax becomes more noticeable. This is often the point where business owners start looking at S-Corp taxation as a way to reduce payroll taxes legally.
The IRS provides details on self-employment tax on the website.
How S-Corporations Are Taxed
S-Corporations are often chosen for one main reason.
They can reduce self-employment taxes when structured correctly.
However, they come with stricter rules and more ongoing requirements than a standard LLC.
Pass-Through Taxation Explained
An S-Corporation is a pass-through entity for federal income tax purposes.
This means:
- The S-Corp does not pay federal income tax at the business level
- Profits pass through to the owners
- Owners report their share of income on their personal tax returns
The business files Form 1120-S, but it generally does not pay income tax itself. Instead, each owner receives a Schedule K-1 showing their share of profit or loss.
This structure avoids the double taxation that applies to C-Corporations.
Reasonable Salary Requirement
One of the most important rules for S-Corporations is the reasonable salary requirement.
If you own and work in an S-Corp, the IRS requires you to pay yourself a reasonable salary for the work you perform. This salary must be paid through payroll and reported on a W-2.
That salary is subject to:
- Federal income tax
- Social Security and Medicare taxes
- State payroll taxes, where applicable
You cannot avoid payroll taxes by paying yourself only distributions. The IRS closely watches this area, and underpaying salary is a common audit trigger.
Self-Employment Tax Savings
The main tax benefit of an S-Corp comes from how remaining profits are treated.
After paying a reasonable salary:
- Remaining profits are distributed as dividends
- These distributions are not subject to self-employment tax
- They are still subject to income tax
For example, if your S-Corp earns $150,000 and you pay yourself a $70,000 salary, only that salary is subject to payroll taxes. The remaining $80,000 can be taken as distributions that avoid Social Security and Medicare taxes.
This is where real tax savings can occur, especially once profits exceed $50,000 to $70,000 per year.
How C-Corporations Are Taxed
C-Corporations are taxed very differently from LLCs and S-Corps.
While they are often seen as less tax-efficient for small businesses, there are situations where a C-Corp can make sense.
The key is understanding how corporate taxes work and how owners are taxed when money leaves the company.
Corporate Income Tax Basics
A C-Corporation is a separate legal and taxable entity.
This means:
- The business pays its own federal income tax
- Profits are taxed at the corporate level before owners receive any money
Under current law, C-Corporations pay a flat federal corporate income tax rate. This rate applies regardless of how much profit the business earns.
The corporation files Form 1120 and pays tax directly to the IRS.
Owners do not report corporate profits on their personal returns unless money is distributed to them.
Double Taxation Explained
One of the biggest concerns with C-Corporations is double taxation.
Double taxation happens in two steps:
- The corporation pays tax on its profits
- Owners pay tax again when profits are distributed as dividends
For example, if a C-Corp earns $100,000 in profit, the corporation pays corporate income tax on that amount. If the remaining profit is then paid out to shareholders as dividends, the shareholders pay personal tax on those dividends.
This is why C-Corps are often viewed as less tax-efficient for owners who want to take profits out regularly.
Salary vs Dividends
Owners who work in a C-Corporation can receive money in two main ways.
- Salary
If you work for the corporation, you can be paid a salary. This salary:
- Is deductible to the corporation
- Is subject to payroll taxes
- Is taxed as ordinary income on your personal return
Paying salary reduces the corporation’s taxable income, which can help limit double taxation.
- Dividends
Dividends are paid from after-tax profits. They are not deductible to the corporation and are taxed again at the shareholder level.
Because of this, many small C-Corps focus on paying reasonable salaries rather than large dividends.
When C-Corps Make Sense
Despite double taxation, C-Corps can be a good fit in certain cases.
They may make sense if:
- You plan to reinvest profits rather than distribute them
- You are seeking outside investors or venture capital
- You want to offer multiple classes of stock
- You plan to sell the business as stock in the future
For businesses that plan to grow quickly and reinvest earnings, paying corporate tax once and delaying personal tax can be a strategic choice.
Side-by-Side Tax Comparison
Looking at each structure on its own is helpful, but the real clarity comes when you compare LLCs, S-Corps, and C-Corps side by side.
This is where you start to see how the same business income can lead to very different tax outcomes.
| Feature | LLC | S-Corp | C-Corp |
|---|---|---|---|
| Entity level income tax | No | No | Yes |
| Pass-through income | Yes | Yes | No |
| Self-employment tax | Yes on all profit | Only on salary | No |
| Payroll required | No | Yes | Yes |
| Double taxation | No | No | Yes |
| Best for | Simple businesses | Profitable owner-run businesses | Growth and reinvestment |
Seeing these differences together makes it easier to understand why entity choice matters so much for taxes.
Owner Compensation and Profit Distribution
How you pay yourself as a business owner has a direct impact on your tax bill.
Each structure handles owner compensation differently, and understanding these differences helps you avoid costly mistakes and stay compliant.
How Owners Get Paid in Each Structure
The way you take money out of the business depends on the entity type.
- LLC
If your LLC is taxed as a sole proprietorship or partnership, you generally take money out through owner draws. These draws are not considered wages. There is no payroll, and no tax is withheld when you take the money out.
Instead, you pay income tax and self-employment tax on the business profit, regardless of how much cash you withdraw.
- S-Corporation
In an S-Corp, you wear two hats. You are both an owner and an employee.
You must be paid a reasonable salary through payroll for the work you perform. This salary is subject to payroll taxes and reported on a W-2. After paying that salary, you can take additional profits as distributions.
Distributions are not wages and are not subject to payroll taxes, which is where tax savings can occur.
- C-Corporation
In a C-Corp, owners who work in the business are paid salaries just like employees. These salaries are deductible to the corporation and subject to payroll taxes.
Owners may also receive dividends. Dividends are paid from after-tax profits and are taxed again at the personal level.
Tax Efficiency of Each Method
Each compensation method has different tax consequences.
With an LLC:
- All profits are subject to income tax and self-employment tax
- Draws themselves do not change the tax outcome
With an S-Corp:
- Salary is subject to income tax and payroll taxes
- Distributions are subject to income tax only
- A proper balance between salary and distributions is key
With a C-Corp:
- Salary reduces corporate taxable income
- Dividends do not reduce corporate tax and are taxed again to you
This is why many owner-run businesses use S-Corps once profits grow.
They allow you to legally reduce payroll taxes by splitting income between salary and distributions.
State and Local Tax Considerations
Federal taxes are only part of the picture.
State and local taxes can significantly change how much you owe each year, and the impact often depends on your business structure and where you operate.
Ignoring state-level taxes can lead to unexpected costs, especially as your business grows.
State Income Taxes
Most states tax business income in some form, but how that tax is applied depends on the entity type.
For LLCs and S-Corporations:
- Business income usually passes through to the owner’s personal state tax return
- You pay state income tax based on your share of the profit
- Tax rates vary widely by state
For C-Corporations:
- The corporation pays state corporate income tax
- Owners pay personal state tax only on salaries and dividends
Some states have high personal income tax rates, which can reduce the benefit of pass-through taxation.
In other states, corporate tax rates may be lower, making C-Corps more competitive from a state tax perspective.
Franchise and Gross Receipts Taxes
In addition to income taxes, many states impose other business taxes.
Common examples include:
- Franchise taxes
- Annual LLC or corporate fees
- Gross receipts taxes are based on revenue rather than profit
For example, some states charge an annual fee simply for having an LLC or corporation registered, regardless of income. Others tax gross revenue, which can be costly for low-margin businesses.
These taxes apply differently depending on entity type and state, so they should be factored into your decision.
SALT Deduction Considerations
The State and Local Tax deduction, often called the SALT deduction, affects how much state tax you can deduct on your personal return.
For pass-through entities:
- State income taxes paid by the owner may be limited on the personal return
- This can reduce the overall tax benefit of pass-through income
C-Corporations:
- Can deduct state and local taxes fully at the corporate level
- This can make C-Corps more attractive in high-tax states
State and local tax rules change frequently, so reviewing them regularly is important, especially if you operate in multiple states.
Which Structure Is Best at Different Income Levels
Your income level plays a major role in deciding whether an LLC, S-Corp, or C-Corp makes the most tax sense.
The best structure at one income level may not be the best choice as your business grows.
Looking at income ranges helps you set realistic expectations and avoid switching too early or too late.
Low-Income Businesses
If your business is earning a relatively low profit, simplicity usually matters more than advanced tax planning.
At lower income levels:
- An LLC taxed as a sole proprietorship or partnership is often the easiest option
- Compliance costs are low
- There is no payroll to manage
- Tax savings from an S-Corp are usually minimal
When profits are modest, the added costs of payroll, additional tax filings, and bookkeeping in an S-Corp can outweigh any self-employment tax savings.
Many businesses stay as LLCs during this phase and focus on growth.
Mid-Income Businesses
As profits increase, the tax picture starts to change.
For many owner-run businesses, the S-Corp becomes attractive once profits reach a consistent mid-range. At this level:
- Self-employment taxes on all LLC profits become noticeable
- Splitting income between salary and distributions can create real savings
- The cost of payroll and compliance is easier to justify
This is often the stage where business owners consider making an S-Corp election.
The key is paying a reasonable salary and documenting compensation decisions properly.
High-Income Businesses
At higher income levels, tax planning becomes more strategic.
Depending on your goals:
- An S-Corp can still provide payroll tax savings
- A C-Corp may make sense if profits are reinvested rather than distributed
- State tax considerations become more important
High-income businesses may also benefit from more complex planning around compensation, benefits, and retained earnings.
At this stage, entity choice should be reviewed regularly rather than treated as a one-time decision.
Conclusion
Choosing between an LLC, S-Corp, and C-Corp is not just a legal decision.
It is a tax decision that can affect how much you pay each year, how you pay yourself, and how your business grows over time.
There is no single structure that is best for every business.
An LLC offers simplicity and flexibility, especially in the early stages.
An S-Corp can create meaningful tax savings once profits increase, but only when it is set up and managed correctly.
A C-Corp can make sense for businesses that plan to reinvest profits, raise capital, or operate at a larger scale, even though double taxation is a concern.
Many business owners stick with the structure they started with and never revisit it.
Others switch based on advice they hear online without understanding the full tax impact.
Both approaches can be costly.
Virtue CPAs helps business owners evaluate and optimize their entity structure with taxes in mind. Our experienced CPAs look at your income, compensation strategy, state tax exposure, and future plans to recommend the structure that makes the most sense for you.
Whether you are deciding between an LLC and an S-Corp, considering a C-Corp, or wondering if it is time to change your current setup, Virtue CPAs provides clear, practical guidance tailored to your business.
Contact Virtue CPAs for a professional tax consultation.
Frequently Asked Questions
Rick Patel
