LLC vs. S Corporation for Taxes

Choosing how your business is structured can have an important impact on taxes, payroll, administrative requirements, and how you pay yourself. Two terms business owners frequently encounter are LLC and S corporation, but they do not describe exactly the same thing.

An LLC is a legal business structure, while an S corporation is a federal tax election. In many cases, an LLC can elect to be taxed as an S corporation.

Understanding the differences can help business owners determine whether an S corporation election may make sense for their situation.

How Is an LLC Taxed?

The way an LLC is taxed depends on the number of owners and the tax elections the business makes.

A single-member LLC is generally treated as a disregarded entity for federal income tax purposes unless another election is made. Business income and expenses are typically reported on the owner's individual tax return.

A multi-member LLC is generally taxed as a partnership unless it elects another form of taxation.

Depending on the circumstances, an LLC may also elect to be taxed as a corporation or an S corporation.

What Is an S Corporation?

An S corporation is a tax classification available to qualifying businesses.

Instead of the business generally paying federal income tax at the corporate level, income and certain other tax items typically pass through to the shareholders and are reported on their individual tax returns.

For many small-business owners, one of the biggest reasons to consider S corporation taxation is how compensation and business profits may be treated for employment tax purposes.

LLC vs. S Corporation: What's the Tax Difference?

A business owner operating through an LLC taxed in its default manner may generally be subject to self-employment taxes on applicable business earnings.

With an S corporation, an owner who performs services for the business generally must receive reasonable compensation as wages. Those wages are subject to applicable payroll taxes.

Additional business profits may potentially be distributed to the shareholder without being treated as wages for employment tax purposes.

This distinction is one reason profitable businesses sometimes consider an S corporation election.

However, electing S corporation treatment does not automatically mean a business will pay less tax.

What Is Reasonable Compensation?

Reasonable compensation is an important consideration for S corporation owners who work in their businesses.

You generally cannot simply take all business profits as distributions while paying yourself little or no salary.

Determining an appropriate salary can involve factors such as:

• Your responsibilities

• Experience and qualifications

• Time devoted to the business

• Services you perform

• Comparable compensation in your industry

• The financial circumstances of the business

Proper payroll and recordkeeping become especially important once an S corporation election is made.

Are There Additional Costs With an S Corporation?

Potential tax savings should be weighed against the additional administrative responsibilities.

An S corporation may require:

• Payroll processing

• Payroll tax filings

• A separate business tax return

• Additional bookkeeping

• Reasonable compensation documentation

• More detailed compliance and recordkeeping

For a business with relatively little profit, these additional costs and responsibilities may outweigh potential tax benefits.

When Might an S Corporation Make Sense?

An S corporation election may be worth evaluating when a business is consistently profitable enough to pay the owner reasonable compensation while still generating additional earnings.

The decision should consider more than revenue alone.

Business owners should evaluate profitability, payroll costs, anticipated growth, administrative expenses, retirement planning, state tax considerations, and their broader financial situation.

When Might an LLC Be the Better Choice?

Remaining with the default LLC tax treatment may make sense for newer businesses, businesses with lower or inconsistent profits, or owners who value a simpler administrative structure.

An LLC can provide flexibility while the business grows, and the possibility of making a different tax election can be evaluated later as circumstances change.

The right structure depends on the individual business rather than a universal income threshold.

Can an LLC Become an S Corporation?

An eligible LLC can generally elect to be treated as an S corporation for federal tax purposes without changing the underlying LLC legal structure.

However, eligibility requirements, filing procedures, and deadlines apply.

Business owners considering an election should ideally evaluate the decision before the desired effective date rather than waiting until tax filing season.

Choosing the Right Tax Structure for Your Business

The lowest-tax option on paper is not necessarily the best structure for every company.

Consider factors such as:

• Current and expected business profits

• How much you reasonably need to pay yourself

• Payroll and accounting costs

• Number and type of owners

• Future growth plans

• Retirement contributions

• State and local tax implications

• Administrative complexity

Running the numbers for your specific situation can provide a much clearer answer than choosing a structure based on a general rule of thumb.

Small Business Tax Guidance From James Ridout CPA

James Ridout CPA works with business owners and entrepreneurs to navigate business taxation, accounting, tax planning, and other financial decisions.

Whether you're starting a new LLC, considering an S corporation election, or wondering whether your current tax structure still makes sense, our team can help you understand the options and evaluate the potential tax implications.

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This article is intended for general informational purposes and should not be considered individualized tax, legal, or financial advice. Business structure and tax treatment depend on individual circumstances and applicable law.