Sole proprietor, LLC, or S-corp: how each is taxed
Sole proprietor, LLC, and S-corp aren't three flavors of the same thing, they're a mix of legal structure and tax treatment. Here's how each actually affects what you owe.
Sole proprietorship
The default when you start working for yourself, no paperwork required. Your business profit flows onto Schedule C, and the full net profit is subject to self-employment tax (15.3%) plus income tax. Simple, but no liability separation between you and the business.
Single-member LLC
An LLC is a legal structure, not a tax one. By default the IRS treats a single-member LLC as a disregarded entity, taxed identically to a sole proprietorship (Schedule C, full self-employment tax). What you gain is liability protectionand a cleaner business identity; what you don't gain, by itself, is a lower tax bill.
S-corp election
An S-corp isn't a separate kind of company, it's a tax election a corporation or LLC can make. Here the math changes:
- You pay yourself a reasonable salary as W-2 wages , that part is subject to Social Security and Medicare.
- Remaining profit comes out as distributions, which are not subject to self-employment tax.
- That split can cut the 15.3% you'd otherwise pay on all profit, the core S-corp tax benefit.
The trade-offs are real:
- You must run actual payroll and withhold on your salary.
- The salary has to be “reasonable” for your role, the IRS scrutinizes artificially low salaries used to dodge payroll tax.
- You file a separate return (Form 1120-S) and typically pay for payroll and bookkeeping, costs that only pay off above a certain profit level.
The common thread
All three are pass-through, the business itself doesn't pay federal income tax; profit passes to your personal return. So good forecasting matters regardless of structure: you still need to know what you'll owe and set it aside. Taxottic forecasts that for sole proprietors, LLCs, and S-corps alike.
Frequently asked
Does forming an LLC change how I'm taxed?
By default, no. A single-member LLC is a disregarded entity, the IRS taxes it exactly like a sole proprietorship, on Schedule C, with all profit subject to self-employment tax. An LLC gives you legal liability protection and a more formal business identity, but on its own it doesn't lower your taxes. What can change your taxes is electing to have the LLC taxed as an S-corp.
How does an S-corp save on taxes?
With an S-corp election, you pay yourself a reasonable salary (W-2 wages, subject to Social Security and Medicare) and take remaining profit as distributions, which are not subject to self-employment tax. That can reduce the 15.3% SE tax you'd otherwise pay on all profit. The catch: you must run payroll, pay yourself a defensible “reasonable” salary, and file a separate corporate return (Form 1120-S), added cost and complexity that only pays off above a certain profit level.
When should I consider an S-corp?
Usually once your net profit is consistently high enough that the self-employment-tax savings exceed the cost of payroll, bookkeeping, and a separate tax return, often discussed around the $40,000-$80,000+ profit range, but it depends entirely on your numbers and state. Because the reasonable-salary rules and break-even math are situation-specific, this is the decision most worth running past a CPA before you elect.
This guide is general information, not tax, legal, or accounting advice, and isn't a substitute for a licensed CPA or tax attorney. Tax rules change and depend on your situation; figures here are illustrative. Verify specifics against current IRS guidance or with your preparer.