S-Corporation vs. LLC: Tax Liabilities You Should Consider

30 November 2025

When you're starting a business, one of the biggest decisions you'll make (besides what to name your company!) is choosing the right business structure. And if you're stuck between an S-Corporation and an LLC, you're not alone. These two options are popular—especially among small business owners—but they come with different tax rules and liabilities. And yeah, that can get confusing fast.

So, which one is better? Well, the answer isn’t that simple. They both have perks. They both have pitfalls. Understanding how each structure handles taxes can save you thousands—or trigger an unexpected visit from the IRS.

Let’s break it all down and figure out which tax setup fits your business like a glove. Sound good? Let’s dive in.

What Is an LLC, Anyway?

An LLC—short for Limited Liability Company—is like the hybrid car of business structures. It combines the flexibility of a sole proprietorship with the liability protection of a corporation. Think of it as the "best of both worlds" vehicle for new business owners.

Here's what makes LLCs so attractive:

- Pass-through taxation: Profits skip corporate taxes and land directly on your personal income tax return.
- Limited liability: Your personal assets (like your car and house) are generally safe if your business gets sued.
- Flexible management: You can run your LLC solo or with a team of partners.

But wait—what about taxes?

How LLCs Are Taxed

By default, the IRS doesn’t tax LLCs directly. They “pass through” all profits and losses to the owners, a.k.a. members. That means you report your share of business income on your personal tax return using a Schedule C, E, or F depending on the nature of your income.

If you’re a single-member LLC, it gets taxed like a sole proprietorship.

If you have multiple members? Then, the IRS treats it as a partnership.

Cool, right? But here comes the catch: Self-employment taxes. Yikes.

Self-Employment Taxes? What’s That?

Here’s the kicker with LLCs—you're responsible for paying self-employment taxes on top of income taxes. That’s 15.3% (ouch!) covering Social Security and Medicare.

Let me break that down:

- 12.4% goes to Social Security
- 2.9% goes to Medicare

And that’s before you even pay your regular income tax. So yeah, it adds up fast.

Introducing the S-Corporation

Now let's talk about the S-Corporation, or "S-Corp" for short. Despite the name, it’s not actually a separate business entity like an LLC or C-Corp.

Instead, it's a tax classification.

Yep, you heard that right. You can actually form an LLC and elect to be taxed as an S-Corporation. Mind blown?

Here’s the magic of the S-Corp: it can help you save BIG on self-employment taxes. But (and it’s a big but), it comes with more rules and red tape.

How S-Corps Are Taxed (Why Some Call It the “Tax Loophole”)

S-Corps are also pass-through entities, so you still report income on your personal tax return. But, here’s where it gets juicy:

Instead of paying self-employment taxes on all the business income, you only pay it on the salary you take from the company. The rest? It's treated as a distribution—which isn’t hit with self-employment tax.

Let’s use an example to paint the picture.

Example Breakdown:

Let’s say your business pulls in $100,000 in profit.

- As an LLC, you'd pay the 15.3% self-employment tax on the whole $100,000. That’s $15,300.
- As an S-Corp, you might pay yourself a “reasonable” salary of $50,000 and take the other $50,000 as a distribution.
- Self-employment taxes only apply to the $50,000 salary → That’s $7,650 in payroll taxes.
- You save nearly $7,650 in taxes. Not bad, right?

Sounds like magic? It's not. It’s just the IRS letting you play within the rules.

What’s a “Reasonable Salary,” Anyway?

Before you go and pay yourself a $1 salary to skip taxes—hold up. The IRS requires business owners to pay themselves a reasonable compensation for the work they do.

What counts as reasonable? Well, it depends on:

- Industry standards
- Your experience and role
- How much time you spend working in the business

If the IRS thinks you’re lowballing your salary to dodge taxes, they might step in—and trust me, you don’t want that kind of smoke.

Comparing LLC and S-Corp: Tax Differences at a Glance

| Feature | LLC (Default Taxation) | S-Corp |
|--------|------------------------|--------|
| Taxation Type | Pass-through | Pass-through |
| Self-Employment Tax | On entire profit | Only on salary portion |
| Payroll Requirements | Not required | Must pay yourself a reasonable salary |
| Distributions | No special tax treatment | Not subject to self-employment tax |
| IRS Scrutiny | Lower | Higher (especially on low salaries) |
| Tax Filing Complexity | Simple | More complex (W-2s, payroll, extra forms) |

Additional Costs to Consider

Yes, S-Corps can save you money, but they’re also more expensive and time-consuming to maintain.

Here's what you'll deal with as an S-Corp:

- Payroll systems: You’ll need one to process your own salary.
- Quarterly filings & W-2s: More paperwork.
- State fees: Some states don’t recognize S-Corps or impose extra taxes (we’re looking at you, California).
- More expensive CPAs: Tax pros charge more for S-Corp filings because of the added complexity.

So, if you’re not making consistent profits or you’re just starting out, the cost of maintaining an S-Corp might eat into your savings.

When Is an LLC Better from a Tax Perspective?

If you're just starting out, have modest income, or want flexibility, an LLC might be your best bet.

Here’s why:

- No payroll headaches
- Fewer administrative obligations
- Easy to file taxes
- Great for side hustles or solopreneurs

You’ll pay more in self-employment taxes, sure—but you’ll save time and stress, which sometimes matters more than money.

When Does It Make Sense to Switch to an S-Corp?

Once your business hits a certain profit threshold (many CPAs say around $40,000 to $60,000 in net income), it might make sense to switch to an S-Corp. That’s where the tax savings begin to outweigh the extra hassle.

Pro tip? Start as an LLC, then elect to be taxed as an S-Corp once the money’s rolling in. It’s the business version of leveling up in a video game.

What About State Taxes?

Here’s something a lot of people forget: state taxes can change the game.

Some states:

- Don’t recognize S-Corps at all (looking at you, New York and New Jersey).
- Still charge extra fees or franchise taxes.
- Require annual reports, even if you're not making money.

So, always check your state’s requirements. IRS rules are just the beginning.

The Hybrid Approach: LLC Taxed as an S-Corp

Can’t decide? You don’t have to.

Many business owners start as an LLC and later elect to be taxed as an S-Corp by filing IRS Form 2553. That way, you get the protection and flexibility of an LLC with the tax perks of an S-Corp.

It’s like turning your Honda Civic into a Tesla—without buying a whole new car.

So... Which One Should You Choose?

Alright, let’s sum it up. If taxes are your biggest concern (and let’s be real, they probably are), here’s a quick cheat sheet.

Choose an LLC if you:

- Want simple taxes
- Are just getting started
- Don’t want to deal with payroll and bookkeeping
- Plan to reinvest most profits into the business

Choose an S-Corp if you:

- Make $40K+ in net profits annually
- Want to reduce self-employment tax liability
- Are okay with payroll and more complex tax filings
- Have a CPA to help out

Just remember: there’s no one-size-fits-all answer. What works for your friend’s Etsy shop might not work for your marketing agency. Talk to a tax pro before you make the leap.

Final Thoughts

Choosing between an LLC and an S-Corp comes down to more than just taxes, but understanding the tax implications can help you keep more money in your pocket—and less in Uncle Sam’s.

Here’s the bottom line:

- LLCs = Simplicity, but more self-employment tax.
- S-Corps = Complexity, but potential tax savings.

Whatever you choose, make sure it aligns with your business goals and financial reality. A little effort today can bring massive savings tomorrow.

And hey—if you mess up? You’re not stuck forever. Business structures and tax treatments can be changed. Just treat this like a GPS—if you take the wrong turn, you can always reroute.