Key Takeaways

  • Both LLCs and S-corps provide liability protection and pass-through taxation but differ in how income is taxed.
  • LLC members pay self-employment taxes on all business profits, while S-corp owner-employees pay these taxes only on wages, not dividends.
  • S-corps may lower overall tax liability for businesses with higher profits by splitting income between salary and distributions.
  • LLCs offer more flexibility in ownership and management, while S-corps face restrictions on shareholders and eligibility.
  • Choosing between an LLC and an S-corp depends on profit levels, growth goals, and compliance preferences.

The differences in LLC vs. S-corp tax mainly involve how much money is paid in self-employment taxes. S-corp is not an actual business structure; it's simply a tax designation that an LLC may choose. Knowing the advantages and disadvantages of an LLC vs. an S-corp can help you make the right decision when forming your business.

Tax Differences Between S-Corps and LLCs

People who want to run a business that offers the benefits of pass-through taxation and liability protection often choose to form LLCs (limited liability companies) or S-corporations.

LLCs offer protection for an owner's personal assets from the following: 

  • Company debts 
  • Company losses 
  • Court rulings against the business 

LLCs are also exempt from double taxation that C-corps are subject to because, in an LLC, all the company's income passes through to each owner's (or member's) personal tax return.

An S-corporation structure also offers personal asset protection from corporate liability. It passes through income as well, typically in the form of dividends, so there's no double taxation (on the personal and corporate level). In this way, S-corps and LLCs are similar. However, there are important differences between the two that you should carefully consider when deciding which type of business you want to form.

The IRS categorizes businesses as one of the following types, for tax purposes: 

There's no classification for LLCs, so LLCs are treated as another type of business. The IRS taxes single-member LLCs as sole proprietorships, and it taxes multimember LLCs as partnerships. You can opt to have your LLC taxed as a C-corp or S-corp.

Eligibility and Structural Differences

While both LLCs and S-corps offer liability protection and pass-through taxation, they differ significantly in ownership rules and structural requirements. LLCs provide the greatest flexibility—members can be individuals, corporations, or even other LLCs, and there is no limit on the number of members. By contrast, S-corps must adhere to stricter rules: they are limited to 100 shareholders, all of whom must be U.S. citizens or residents, and cannot include corporations, partnerships, or certain trusts.

Additionally, LLCs have more flexible management structures, allowing either member-managed or manager-managed systems. S-corps, however, must follow a more formal corporate structure with directors, officers, and regular shareholder meetings

How Much in Taxes Will You Pay?

For most small-business owners, the biggest difference is in how Medicare and Social Security taxes (or self-employment taxes) are treated. By choosing the S-corp designation, you may be able to save money on taxes.

LLC members report their business income and expenses on their personal tax returns. They pay taxes on the company profits. Because members are treated as self-employed individuals, they're responsible for self-employment taxes on those profits.

Effective as of 2016, a self-employed person pays a Social Security tax of 12.4 percent on the first $118,500 of income, along with a 2.9 percent Medicare tax. High earners pay an added 0.9 percent in Medicare tax. Employees pay these taxes too, but their employer pays half, so employees only pay the other half.

Tax Savings Potential

The most significant consideration in the s corp vs llc taxes debate is how much money you can potentially save. With an LLC, all profits are subject to self-employment taxes, which cover Social Security and Medicare. For owners who earn modest profits, this simplicity is often cost-effective.

In an S-corp, however, owners can split income between a “reasonable salary” (subject to payroll taxes) and shareholder distributions (not subject to self-employment taxes). This arrangement may reduce the total tax burden, especially for businesses with profits that significantly exceed what would be considered a reasonable salary.

For example, if your company earns $200,000 in profits and you pay yourself an $80,000 salary, only that $80,000 would be subject to Social Security and Medicare taxes. The remaining $120,000 could be distributed as dividends, avoiding additional self-employment taxes

More on S-Corps

A member can be considered an employee of the company in an S-corp. If you're an owner-employee, you should receive a reasonable salary. The salary is reported as a business expense, and the owner reports the salary, as well as any remaining business profits on a personal tax return. Compared to an LLC's sole proprietor who's responsible for Social Security and Medicare taxes on all profits, an S-corp's owner pays these taxes only on the owner's salary and not any remaining profits.

The IRS clearly spells out who can quality as an S-corp, so not every business can choose this tax designation. The majority of single-member LLCs are eligible, but the following can't choose the S-corp classification: 

  • Foreign LLCs 
  • LLCs with an owner who's a nonresident alien 
  • An ownership structure that's a partnership or corporation 
  • Multimember LLCs with more than 100 members

Before choosing to operate as an S-corp, consider if you'll actually save money under that classification as well as what is a reasonable salary for your defined job. If company profits are higher than a reasonable salary, you may save money as an S-corp.

You can change your company's tax status if you have already started your LLC but aren't happy with the tax consequences. If you want to make the switch, you can choose the S-corp status any time during the tax year, prior to the year you want your changes to take effect. You can also make the change within the first 75 days of the current year.

While tax benefits are always appealing, not everyone is able to operate as an S-corp or even needs to. If you're not happy with your current designation, however, you may be able to change it for the future.

Compliance Obligations and Drawbacks

While S-corps offer potential tax savings, they come with added administrative and compliance requirements. Owners must run payroll, file corporate tax forms, and maintain corporate records such as bylaws and meeting minutes. These requirements add complexity and costs compared to an LLC’s generally simpler recordkeeping obligations.

Another consideration is that S-corps can face closer IRS scrutiny regarding what qualifies as a “reasonable salary.” Paying yourself too little to minimize payroll taxes may trigger penalties. By contrast, LLC owners have fewer compliance risks since all profits are automatically subject to self-employment taxes.

Because of these trade-offs, an S-corp designation typically benefits businesses that generate consistent profits beyond what would reasonably be paid in wages, whereas LLCs may be better suited for startups or businesses with fluctuating income

Frequently Asked Questions

1. Is it always cheaper to be taxed as an S-corp instead of an LLC?

Not always. S-corps can reduce self-employment taxes on distributions, but the added costs of payroll, compliance, and IRS scrutiny may outweigh savings for smaller businesses.

2. Can a single-member LLC elect to be taxed as an S-corp?

Yes. A single-member LLC can file IRS Form 2553 to elect S-corp status if it meets eligibility requirements.

3. What qualifies as a “reasonable salary” for S-corp owners?

The IRS requires that owner-employees pay themselves a salary comparable to what someone with similar experience would earn for the same role.

4. Do LLCs have to pay corporate taxes?

By default, LLCs are pass-through entities, meaning profits are taxed on owners’ personal returns. However, an LLC can elect corporate taxation if desired.

5. Which is better for reinvesting profits: LLC or S-corp?

An LLC offers more flexibility for reinvestment without strict salary rules. S-corps may be better if you plan to distribute profits and want to minimize payroll taxes.

If you need help with deciding between an LLC and S-corp, you can post your legal need  on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.