Key Takeaways

  • Both LLCs and S Corps provide liability protection and pass-through taxation, but they differ in how self-employment taxes and distributions are treated.
  • The benefits of S Corp vs LLC often come down to tax savings on self-employment income and payroll flexibility.
  • S Corps allow owners to pay themselves a salary and take additional profits as distributions, potentially lowering Medicare and Social Security taxes.
  • LLCs offer greater flexibility in management and ownership structures but may lead to higher self-employment tax burdens if not electing S Corp status.
  • Choosing between the two depends on factors like income level, growth goals, and administrative preferences.

The tax advantages of LLCs vs S Corporations, or S Corps, depend on how the LLC has opted to be viewed in the eyes of the IRS.

What Are LLCs and S Corps?

An LLC is a type of business entity while an S Corp is merely a tax designation. 

The actual definition of an LLC depends on the state in which it is formed. LLCs are basically business entities that protect their owners or members from liabilities and can choose how they would like to be taxed — as a corporation or a disregarded entity.

LLCs may have one or several members and so be called either a single-member LLC or multi-member LLC.

This type of business entity is very popular with small business owners and entrepreneurs because it allows for a lot of freedom in the structure of the company as well as providing legal protection and low financial risk. Corporations tend to require more reporting and have more regulations when it comes to management and organizational decisions for the company.

An S Corp is a specific tax designation recognized by the Internal Revenue Service (IRS) and Internal Revenue Code (IRC), so an LLC can actually also be an S Corp if it files a Form 2553 to elect that specific status.

Choosing the Right Entity for Your Business Goals

Selecting between an LLC and an S Corp depends on long-term business goals, income level, and administrative preferences.

  • Choose an LLC if:
    • You want a simple structure with minimal paperwork.
    • Flexibility in ownership and profit sharing is important.
    • You plan to reinvest profits rather than take distributions.
  • Choose an S Corp if:
    • You expect consistent profits and want to minimize self-employment taxes.
    • You’re comfortable with payroll obligations and IRS oversight.
    • You plan to grow the business with employees or investors.

Both structures offer liability protection and pass-through taxation, but S Corps require more documentation and compliance oversight. Small businesses often start as LLCs and elect S Corp status later once profits justify the additional complexity.

Tax Benefits of S Corp Versus LLC

The IRS recognizes these four different tax designations for companies:

LLCs are not actually a type of business structure in the eyes of the IRS, but they must elect a particular designation.

Single-member LLCs are taxed as sole proprietorships while multi-member LLCs are taxed as partnerships unless they request otherwise.

By filing the correct paperwork, LLCs can elect to be taxed as either C Corps or S Corps.

The biggest difference between sole proprietorships and S Corps is how they handle Medicare and Social Security taxation or self-employment taxes for the company. Electing S Corp taxation status is a way for owners of LLCs to sometimes cut costs.

Comparing Income, Deductions, and Self-Employment Taxes

When comparing the benefits of S Corp vs LLC, one of the most critical distinctions lies in how each handles income and self-employment taxes.

1. Self-Employment Tax Savings:

  • LLC Members: By default, LLC members pay self-employment taxes (Social Security and Medicare) on their full share of business income. This can lead to a substantial tax bill if profits are high.
  • S Corp Shareholders: An S Corp allows owners to classify part of their income as salary (subject to employment taxes) and the rest as a distribution (not subject to those taxes). This setup can significantly reduce total self-employment taxes when used properly.

Example:If an LLC member earns $150,000, all of it may be subject to self-employment taxes. In contrast, an S Corp owner earning $150,000 but paying themselves a $70,000 salary may pay employment taxes only on that salary, saving thousands annually.

2. Payroll and Reasonable Compensation Rules:To benefit from this structure, the IRS requires that S Corp owners take a “reasonable salary” based on their role, experience, and industry norms. Underpaying yourself to avoid taxes can result in IRS penalties.

3. Deductible Business Expenses:Both LLCs and S Corps can deduct ordinary business expenses, including health insurance premiums, retirement contributions, and business-related travel. However, S Corp owners who receive a salary can make pre-tax deductions through payroll, while LLC members must often deduct these on their personal returns.

Single-Member LLCs Taxed as Sole Proprietorships

Single-member LLCs have only one owner, so all profits and losses for the company must be recorded on the personal tax returns of that individual. The LLC itself does not pay business taxes.

Because members of single-member LLCs are viewed as owning a sole proprietorship in the eyes of the IRS, they are considered to be self-employed and are therefore required to pay Medicare and Social Security taxes.

Since 2016, the taxes are as follows:

  • Social Security: 12.4 percent on all income under $118,500.
  • Medicare: 2.9 percent, plus an added 0.9 percent for higher incomes.

These taxes are also owed by all employees, but the employer is required to pay half of these taxes while the employee is responsible for the other half.

If the owner of a single-member LLC remains identified as a sole proprietorship, when the company profits $150,000, that individual will pay income taxes on $150,000 and self-employment taxes — which includes Social Security and Medicare — on $150,000.

Single-Member LLCs Taxed as S Corporations

If a single-member LLC elects S Corp status, they will be taxed differently. This way, the sole member is viewed as an employee of the business and must earn a fair wage.

That employee's salary is reported as a business expense by the LLC, and the salary and company profits are taxed as the sole owner's personal income tax.

With the S Corp designation, this owner doesn't have to pay self-employment taxes on all of the profits of the company, but just on their personal salary.

Therefore, if the company profits $200,000, and the sole owner is paid $50,000 for the year, they will pay Social Security and Medicare taxes on $50,000 only, and the total $200,000 is just subject to income taxes.

How Are an LLC and an S Corp Taxed?

LLCs and S Corps are taxed as disregarded entities or pass-through entities. This means that the profits of the company pass to the owners or members and are taxed on their personal income tax returns.

C Corporations are taxed as businesses, and the shareholders are taxed on their shares. This is double taxation. Basically, the profits of the company are taxed twice, once as the company's income, and again as the shareholders' income.

LLCs and S Corps avoid this double taxation.

Administrative and Structural Considerations

The benefits of S Corp vs LLC extend beyond tax differences — each structure has distinct administrative requirements that impact compliance and flexibility.

LLC Advantages:

  • Simpler Management: LLCs allow flexible management structures and fewer formalities like board meetings or bylaws.
  • Flexible Profit Distribution: Profits and losses can be divided among members in any proportion, not necessarily tied to ownership percentages.
  • Ease of Formation: LLCs are typically easier and cheaper to form and maintain at the state level.

S Corp Advantages:

  • Investor Appeal: S Corps may be viewed as more established for investors or lenders due to their corporate structure.
  • Ownership Restrictions: S Corps are limited to 100 shareholders and must all be U.S. citizens or residents.
  • Salary and Distribution Split: Owners can balance payroll and profit distributions to optimize taxation.

Administrative Differences: S Corps require filing Form 1120-S, maintaining corporate minutes, issuing stock, and adhering to formal recordkeeping. LLCs, meanwhile, often only need an operating agreement and annual state filings.

Multi-Member LLCs and S Corp Elections

For multi-member LLCs, electing to be taxed as an S Corp can further amplify the benefits of S Corp vs LLC by allowing members to reduce self-employment taxes while maintaining flexibility in profit distribution.

Key Points:

  • Each member can receive a salary for their active work in the business, subject to payroll taxes.
  • Remaining profits can be distributed to members without additional self-employment tax.
  • However, all shareholders in an S Corp must receive distributions proportionate to their ownership percentages, unlike LLCs, which can customize allocations.

This distinction means that an S Corp election is ideal for businesses with predictable profits and clear ownership roles, while an LLC may suit companies with varying member involvement or reinvestment needs.

Frequently Asked Questions

  1. What’s the biggest tax advantage of an S Corp over an LLC?
    The main advantage is reduced self-employment taxes, since S Corp owners pay employment taxes only on their salaries—not total profits.
  2. Can an LLC change to an S Corp later?
    Yes. LLCs can elect S Corp status by filing IRS Form 2553. Many businesses do this once their income reaches a level where the tax savings outweigh administrative costs.
  3. Are S Corps better for freelancers or small businesses?
    Freelancers with consistent income often benefit from S Corp status because it can lower self-employment taxes, while startups may prefer LLCs for flexibility.
  4. Do both LLCs and S Corps offer liability protection?
    Yes. Both protect owners’ personal assets from business debts and lawsuits, provided business and personal finances are kept separate.
  5. How do states tax S Corps vs LLCs?
    State-level taxes vary. Some states impose franchise or excise taxes on S Corps, while others treat both entities equally. Always check state-specific tax rules before forming your entity.

If you need help with benefits of S corp vs LLC, 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.