LLC vs S-Corp: The Real Tax Difference, Explained

#The decision frame

Every business in the U.S. operates as one of these entity types:

• Sole proprietorship: default if you do nothing
• Partnership: default if 2+ people do nothing together
• Limited Liability Company (LLC): formed at the state level
• S-Corporation: a tax election available to LLCs or corporations
• C-Corporation: a separately incorporated entity, taxed as its own taxpayer

Most owner-operators have a single best answer. Most pick wrong anyway. They choose based on a friend’s advice, or what LegalZoom recommended on the day they formed.

#LLC (Limited Liability Company)

What it is: A state-law entity that gives you asset protection (your business assets stay separate from your personal assets) and operational flexibility. By default, a single-member LLC is taxed as a sole proprietorship. A multi-member LLC is taxed as a partnership.

When it makes sense: Almost always, as the foundation. The LLC is rarely the wrong answer for the legal structure. The question is what tax election you make on top of it.

Cost to operate: State filing fee + annual report. Fees vary by state. Many states charge $100 to $300 a year. Some, like California, charge $800 or more. In Texas, the franchise tax + Public Information Report on top of formation. Minimal operational complexity.

Tax treatment: Single-member LLC defaults to Schedule C (sole prop) on your 1040. Multi-member LLC defaults to partnership (Form 1065). Either can elect S-corp or C-corp tax treatment.

When NOT to use: Rental real estate sometimes belongs in a different structure (DST, partnership-LLC with multiple owners). Pure passive holding might be a trust. Some professional services have state-specific PLLC requirements.

#S-Corp Election (filed on an LLC or Corporation)

What it is: A federal tax election (Form 2553) that changes how the entity is taxed. The entity itself can still be an LLC at the state level. The S-corp is purely a tax classification.

When it makes sense: Net business income clears ~$80K-$100K, and you can document reasonable compensation for the owner. The election often saves about $5,000 to $10,000 a year in payroll tax for owners with $80K or more of profit, before costs. Your amount depends on your profit and your reasonable salary.

Cost to operate: Running payroll for the owner (~$40-$80/mo via Gusto). Reasonable comp documentation maintenance. Slightly more complex tax return (Form 1120-S + K-1s). Net operational cost is real but small compared to the savings.

Tax treatment: Owner pays themselves W-2 wages subject to payroll tax. Remaining net income flows to owners via K-1 as distribution income, not subject to self-employment tax.

When NOT to use: Net income under ~$80K (math doesn’t work). Rental real estate (distribution rules + loss passthrough don’t work). Multiple owners with materially different operating roles (partnership taxation is cleaner). Taking outside investment (VCs want C-corp).

#C-Corporation: C corp vs S corp, and when the C corp wins

What it is: A separately incorporated entity that’s taxed as its own taxpayer at the 21% federal rate. Owners are shareholders; income flows to them only as W-2 wages or dividends.

When it makes sense: Three scenarios, all narrow.

(1) Taking outside investment. VC funds and most institutional investors require C-corp structure (typically Delaware C-corp) for legal reasons. They can’t be in pass-through entities for fund-structure reasons.

(2) Genuinely retaining large profits inside the entity. Say you’re building up working capital, or reinvesting heavily in operations, and you don’t need to take the cash out personally. Keeping profit in a C-corp delays the second tax. But it does not remove it. The 20% pass-through deduction makes the S-corp or LLC rate lower than it looks. The IRS can also tax profits that sit idle with no business need.

(3) QSBS Section 1202 planning. For stock issued after July 4, 2025, founders can exclude gain up to $15 million (or 10 times what they paid, if larger). They get 50% off after 3 years, 75% after 4 years, and 100% after 5 years. Older stock still follows the $10 million and 5-year rule. This can be worth a lot. But only if the stock and the business qualify. The company must be a U.S. C-corp, stay under the asset limit, and run an active business that is not an excluded field such as health, law, finance or consulting.

Cost to operate: Much higher than LLC or S-corp. Separate tax return (Form 1120). Double taxation if you distribute earnings as dividends (corp pays 21%, then dividends are taxed again at 15-20%). Delaware franchise tax + state-level filings. Often $2K-$5K/yr in compliance costs alone.

Tax treatment: Entity-level 21% federal tax. Dividends to shareholders taxed at qualified-dividend rates. Owner compensation via W-2 wages (subject to payroll tax).

When NOT to use: Almost everywhere except the three scenarios above. For 95% of small businesses, C-corp is the wrong answer.

#The three structures at a glance

#Decision flowchart

Here’s the practical decision tree we run on every Discovery call:

For most owner-operators, the answer is the LLC + S-corp election. LLC at the state level, S-corp election on top, reasonable comp benchmarked + documented, payroll through Gusto.

#What about Delaware?

Delaware is the standard for venture-backed C-corps because of well-developed corporate case law and flexible chancery courts. Say you run an LLC in Texas with Texas customers. Delaware adds cost (Delaware franchise tax, Delaware annual reports, and Texas registration as a foreign LLC) without any operational benefit. Form in the state where you actually do business, unless you’re VC-track.

#Common questions

Can I change entity types later? Yes, but with friction. LLC to S-corp is easy, just file Form 2553. Going from an S-corp to a partnership is treated as closing the company. That can cause tax on any gain in the assets. Get tax advice before you do it. LLC to C-corp needs a conversion, and it can be structured tax-free under specific rules. Pick the right structure from the start when possible.

What about the 5-year QSBS clock: can I convert later? Theoretically yes, but the QSBS holding period starts at the qualified entity formation. Say you operate as an LLC for 3 years, then convert to a C-corp. Your QSBS clock starts at conversion, not at original formation. If QSBS is in the plan, start as a C-corp.

Do all states recognize the S-corp election? Most states accept the federal S election. New York needs its own form (CT-6). California and New Jersey follow the federal election, but California adds a 1.5% tax. Check your state. We handle this where applicable.

Can a single-member LLC be a partner in another partnership? Yes. A single-member LLC is a “disregarded entity” by default, which means it can hold partnership interests. Common structure for holdco / opco setups.

C corp vs S corp: what is the main tax difference? An S corp is a pass-through. It generally pays no federal income tax itself. Its profit flows to the owners’ returns on a K-1. A C corp pays its own 21% federal tax on profit. Then the owners pay tax again on any dividends they take out. That second layer is the “double taxation” people talk about. For the dollar math on the S corp side, see our LLC vs S-corp tax math by income level.

Should my small business be a C corp or S corp? For most owner-operators who take the profit home, the S corp is the better fit. It avoids the second layer of tax. The C corp makes more sense in the three narrow cases above: outside investors, keeping large profits inside the company, or a planned QSBS exit. An S corp also has limits a C corp does not. It can have at most 100 owners, and one class of stock. Owners must be U.S. citizens or residents, or certain trusts and estates. A partnership, a corporation, or a multi-member LLC cannot own shares.

Can I switch from a C corp to an S corp later? Yes, by filing Form 2553, but a C corp that converts can owe built-in gains tax on assets that went up in value before the switch. Our guide to converting a C corp to an S corp walks through that tax.

What’s a “Series LLC”? A series LLC is allowed in a limited number of states, where multiple “series” exist under one parent LLC, each with separate liability. Check that your state allows it, and how it treats the liability walls. Useful for real estate investors with multiple properties. We have a dedicated article on Series LLC coming.

What is the S corp tax rate? There is no flat S corp tax rate. An S corp is a pass-through. Its profit flows to the owners on a K-1. Each owner pays tax on their share at their own personal marginal rate, which runs 10% to 37% federal depending on their total income. That is different from a C corp, which pays a flat 21% federal rate (IRC §11(b)) at the entity level before any dividend is taxed again.

Is an LLC an S corp or C corp? Neither, by default. An LLC is a state-law entity, not itself a tax classification. A single-member LLC defaults to being taxed as a sole proprietorship. A multi-member LLC defaults to partnership taxation. Either one can file an election to be taxed as an S corp or a C corp on top of the LLC. But until that election is made, the LLC is neither.

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If you’re forming a new business or restructuring an existing one, the Discovery call is the right next step. We model the right structure against your specific situation and quote the engagement.