LLC vs. S-Corp: Which One Should You Choose?

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Starting a business is exhilarating—until you hit the fine-print section labeled “Choose an Entity.” Suddenly you’re drowning in jargon: “disregarded entity,” “pass-through,” “reasonable salary,” “self-employment tax.” For most U.S. founders, the choice narrows to two popular options: a Limited Liability Company (LLC) taxed in its default status, or that same LLC (or a corporation) that has elected to be treated as an S Corporation (S-Corp) for federal tax purposes. Both shield your personal assets; both are “pass-throughs,” meaning the company itself usually pays no federal income tax. Yet the day-to-day and year-end differences can swing thousands of dollars—and hours—one way or the other.

Below is a 2025-era, practitioner-level comparison that founders, side-hustlers, and scaling start-ups alike can use to decide which structure fits their profit level, growth plans, and tolerance for paperwork.

The 30-Second Cheat Sheet

  • Single-owner service business, modest profit (≲$60k net): Default LLC is usually simpler and cheaper.

  • Owner actively working in the business, profit ≳ $60k – $80k

    80k: Consider an S-Corp election once the tax savings outweigh the extra payroll costs and admin.

  • Multiple owners who want maximum flexibility in profit splits and who value legal simplicity: Default LLC.

  • Owners seeking outside investment or stock option plans: C-Corp (not S-Corp) is usually superior, but if you still want pass-through treatment, an S-Corp can work for <100 shareholders.

  • Business with large capital expenditures and Section 179 or bonus depreciation deductions: S-Corp can shelter the owner’s W-2 wages from SE tax while still allowing full flow-through of depreciation.

  • Professional practices (doctors, lawyers, consultants) in high-tax states: State rules may limit S-Corp eligibility (e.g., California’s 1.5% S-Corp franchise tax), so run a state-specific model.

Quick Definitions & Legal Foundations

Limited Liability Company (LLC)

  • State-created entity. Owners are “members.”

  • Default federal tax treatment:

    • Single-member = disregarded entity (Schedule C).

    • Multi-member = partnership (Form 1065).

  • Members pay self-employment (SE) tax on their share of active business income (15.3% up to the Social Security wage base, 2.9% Medicare thereafter).

S Corporation (S-Corp)

  • A federal tax election under Subchapter S of the Internal Revenue Code, not a separate entity type. An eligible LLC or C-Corp can file Form 2553 to obtain S-Corp status.

  • Key hallmark: Owners who perform services must be paid “reasonable salary” subject to payroll taxes; remaining profit is distributed as dividends not subject to SE tax.

Head-to-Head Comparison

A. Formation & Up-Front Cost

  • LLC: One-stop filing in any state. State filing fees range from $40 (Kentucky) to $500 (Massachusetts). No federal election required.

  • S-Corp election: File Form 2553 within 2 months 15 days of the tax year you want it effective, or use late-election relief (Rev. Proc. 2013-30). No extra state filing in most states, but some (New York City, New Jersey) ignore S-Corp status and tax as C-Corp.

B. Ongoing Formalities

  • LLC: Annual report + franchise tax in many states. Internal governance via Operating Agreement—can be oral or informal if single-member.

  • S-Corp: Must run payroll at least quarterly, file quarterly 941s, annual 940, issue W-2s, maintain corporate minutes, and follow “corporate formalities” to preserve liability shield. Adds 

    600–

    2,000/yr in payroll service or CPA fees.

C. Self-Employment Tax

  • LLC default: Net profit from active business is subject to SE tax on the member’s personal return.

  • S-Corp: Only wages paid to owner-employee are subject to payroll tax (Social Security + Medicare). Distributions escape SE tax. Savings can be substantial once profit exceeds the “reasonable salary” threshold.

    Illustration (2025 figures)
    Net profit before owner salary: $150,000
    Reasonable salary: $70,000
    Payroll tax on salary: $70,000 × 15.3% = $10,710
    SE tax if LLC: $150,000 × 92.35% × 15.3% ≈ $21,185
    S-Corp savings ≈ $10,475 minus extra payroll costs and 2% haircut on QBI (see below).

D. Qualified Business Income (QBI) Deduction

IRC §199A allows up to 20% deduction on pass-through profit. S-Corp wages reduce the base for QBI, shrinking the deduction. Example: $150,000 profit → $30,000 QBI deduction at 20%. If $70k is reclassified as wages, QBI base drops to $80k → $16k deduction. Net impact: S-Corp still usually wins, but the gap narrows.

E. Reasonable Salary Risk

IRS scrutinizes S-Corps that pay zero or artificially low salaries. Case law (Watson, McAlary, Radtke) shows recharacterization penalties. Safe harbor: Benchmark salary surveys, pay at least the Social Security wage base ($168,600 in 2025) for full-time owners in high-earning industries.

F. Health Insurance & Retirement

  • LLC single-member: Health insurance premiums above-the-line if paid by the business, but SE tax still applies.

  • S-Corp ≥2% shareholder: Premiums reported as wages but exempt from payroll tax; can sponsor solo 401(k) with higher contribution limits (employer piece up to 25% of wages).

  • LLC partnership: Partners can’t participate in cafeteria plans; S-Corp can.

G. Losses & Basis

Both structures allow flow-through losses, but you must have “basis” to deduct them. S-Corp basis is stock + loans from shareholder; LLC member basis includes member-level debt. If you expect start-up losses, LLC often provides faster basis creation via member loans.

H. Exit & Sale

Both single-member LLC and S-Corp stock can qualify for Section 1202 100% exclusion if originally formed as C-Corp and later elected S-Corp (rare). More common: sale of LLC interest = capital gain + possible depreciation recapture; sale of S-Corp stock = capital gain. S-Corp built-in gains (BIG) tax (21%) applies if assets appreciated while C-Corp and S election made within 5 years.

I. State Taxes

  • California: $800 LLC franchise fee + LLC fee on gross receipts; 1.5% S-Corp net income tax. Break-even ≈ $53k profit.

  • New York City: S-Corp status is ignored—city tax applies as C-Corp.

  • Texas: No personal income tax; LLC or S-Corp equally favored.

Decision Matrix by Life Stage

Side-Hustle (≤$40k net)

Stick with single-member LLC. Simple Schedule C. No payroll. Deduct home-office, mileage, Section 179 small purchases. SE tax bite is modest; adding S-Corp payroll destroys savings.

Consultant / Freelancer (

60k–

100k)

Run the numbers:
Savings = (SE tax on LLC profit) – (payroll tax on salary) – (costs) – (QBI haircut).
Rule of thumb: Election makes sense around 

60k–

80k net, depending on state and reasonable salary.

Scaling Agency (

200k–

500k)

S-Corp almost always wins. Consider layered strategy:

  • Elect S-Corp for management company.

  • Keep separate LLCs for real estate or equipment to isolate liability and segregate passive income.

Husband-and-Wife Team

LLC taxed as partnership offers flexibility to allocate profits 70/30, 50/50, or based on capital accounts. S-Corp requires equal pro-rata distributions per share class, limiting income shifting.

Real Estate Investor

Pure rental LLCs should stay default (or elect to be taxed as partnerships) to avoid “active trade or business” issues and preserve ability to use losses against other passive income. S-Corp status is rarely beneficial for rentals.

High-Growth Startup Seeking VC

Venture funds dislike pass-through K-1s and prefer C-Corp stock with qualified small business stock (QSBS) potential. Electing S-Corp now and later revoking to C-Corp triggers built-in gains tax—usually ill-advised.

Conversion Mechanics & Timing

From LLC default to S-Corp

File Form 2553 by March 15, 2025 (for calendar-year LLC). Effective date can be retroactive to January 1. Attach IRS “LLC consent” statement.

From S-Corp back to LLC

Must “liquidate” the S-Corp by distributing assets to shareholders, who then contribute to a new LLC—potential gain recognition. Not trivial.

From C-Corp to S-Corp

File Form 2553; watch for built-in gains tax, excess passive income tax, and LIFO recapture.

Late Elections

Rev. Proc. 2013-30 gives 3 years 75 days relief if reasonable cause. Common for new LLCs formed mid-year.

Worked Numerical Example (2025 Rates)

Facts

  • Single-member marketing consultant, calendar year.

  • Net profit before owner comp: $200,000.

  • Reasonable salary for similar role in area: $75,000.

  • State: Illinois (flat 4.95% personal income tax, no S-Corp privilege tax).

  • Payroll service cost: $600/yr.

  • Assume 20% QBI deduction fully available.

Option A – Single-Member LLC

  • SE tax: $200,000 × 92.35% × 15.3% = $28,282

  • Federal income tax (after ½ SE tax deduction): $200,000 – $14,141 = $185,859 taxable.

  • QBI deduction: 20% × $200,000 = $40,000 (subject to wage limit, but assume under threshold).

  • Federal taxable: $185,859 – $40,000 = $145,859.

  • Illinois tax: $200,000 × 4.95% = $9,900.

  • Total tax: Fed + SE + IL ≈ $28,282 + $24,600 + $9,900 ≈ $62,782.

Option B – LLC Electing S-Corp

  • Payroll tax: $75,000 × 15.3% = $11,475 (employer half deductible).

  • Federal taxable wages: $75,000.

  • S-Corp profit: $200,000 – $75,000 – $5,737 employer payroll tax = $119,263.

  • QBI deduction: 20% × $119,263 = $23,853 (wage limit met by W-2).

  • Federal taxable: $75,000 wages + $119,263 profit – $23,853 QBI = $170,410.

  • Federal income tax ≈ $34,300.

  • Illinois: $200,000 × 4.95% = $9,900.

  • Total tax: Fed + payroll + IL ≈ $34,300 + $11,475 + $9,900 = $55,675.

  • Add payroll service cost $600 → $56,275.

  • Net savings vs. LLC ≈ $62,782 – $56,275 = $6,507.

Conclusion: At $200k profit, S-Corp election saves about $6.5k/year.

Common Misconceptions

  • “An LLC is always simpler.”
    True at low profits. At high profits, the extra payroll is outweighed by SE tax savings.

  • “S-Corp owners don’t pay any payroll tax.”
    False—only the profit above reasonable salary escapes it.

  • “I can switch back and forth each year.”
    No. Once S-Corp election is made, you must revoke with IRS consent (5-year wait unless special circumstances).

  • “LLCs can’t sponsor 401(k)s.”
    They can—single-member LLCs are disregarded, so the individual adopts a “solo 401(k).” S-Corp allows a larger employer contribution because the base is W-2 wages.

  • “California LLC fee makes S-Corp cheaper.”
    Only when profit exceeds ≈ $53k because S-Corp pays 1.5% on net. Do the math.

Action Plan: 5-Step Checklist

  1. Project profit for next 12 months.

  2. Benchmark reasonable salary (BLS wage data, industry surveys).

  3. Run side-by-side tax model (include QBI, state taxes, payroll costs).

  4. Check state quirks (CA, NYC, TN).

  5. File paperwork:

    • If S-Corp, Form 2553 + payroll registration + corporate resolution.

    • If LLC, Operating Agreement + EIN + bank account.

Bottom Line

Default LLC is the best “starter jacket” for most U.S. small businesses: cheap, flexible, and protective. The S-Corp election is a performance upgrade that pays off once you’re consistently earning above a threshold—roughly 

60k–

80k of net profit for a solo owner, higher in high-tax states. Think of it as shifting from a Honda Civic to a Tesla: more speed and tax-efficiency, but also more charging ports (payroll, payroll tax filings, corporate minutes). If you’re not ready to plug in every quarter, stay with the Civic. When the savings justify the upkeep, flip the switch—just make sure you do it before the IRS deadline and keep meticulous records so the upgrade doesn’t turn into an audit magnet.

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