Business Structure and Taxes: How LLCs, S-Corps, and C-Corps Are Actually Taxed Differently

Business Structure and Taxes: How LLCs, S-Corps, and C-Corps Are Actually Taxed Differently

Choice of entity is one of the most consequential — and most frequently outdated — decisions a business makes. Many businesses keep the structure they started with long after it stops being the most tax-efficient option for where the business actually is now.

LLCs and Default Pass-Through Taxation

By default, a single-member LLC is taxed as a sole proprietorship and a multi-member LLC as a partnership — in both cases, profit passes through to the owners' personal returns and is subject to self-employment tax on the full amount of profit, not just a salary. This simplicity is attractive early on, but as profit grows, the full self-employment tax exposure becomes a meaningful cost that other structures can reduce.

S-Corp Election: The Self-Employment Tax Workaround

An LLC or eligible corporation can elect S-corp tax treatment, which allows the owner to split income between a reasonable salary (subject to payroll tax) and remaining profit distributions (not subject to self-employment tax). For a profitable business, this split can produce real tax savings — but it requires paying yourself a genuinely "reasonable" salary, a standard the IRS actively scrutinizes, and it adds payroll and filing complexity that isn't worth it at lower profit levels.

C-Corp: Double Taxation, But Sometimes the Right Call

A C-corp pays corporate tax on its profit, and shareholders pay personal tax again on any dividends distributed — the often-cited "double taxation." Despite this, a C-corp structure can make sense for businesses planning to raise venture capital, reinvest most profits rather than distribute them, or offer certain equity compensation structures that pass-through entities can't easily replicate.

The Right Structure Changes as the Business Changes

The entity choice that made sense at formation — often an LLC, for simplicity — frequently stops being the most efficient choice once the business reaches consistent, meaningful profitability. Reviewing entity structure periodically, rather than treating the original choice as permanent, is one of the more overlooked tax planning opportunities available to established businesses.

A structure review doesn't need to happen every year, but revisiting it whenever profitability shifts meaningfully — or before a major event like fundraising or a sale — is worth the conversation.