LLC vs S-Corp vs C-Corp: Tax Implications Explained

April 17, 2026

Choosing between an LLC, S-Corp, and C-Corp isn't a legal decision — it's a tax decision. The entity you pick determines how much you pay in self-employment tax, how you take money out of the business, and how the IRS treats your profits. Here's how each structure works and when to use it.

How Each Entity Is Taxed

LLC (Default Tax Treatment)

A single-member LLC is a "disregarded entity" for tax purposes. All income flows through to your personal return on Schedule C. A multi-member LLC is taxed as a partnership by default, filing Form 1065 with K-1s to each member.

The critical issue: self-employment tax. As a single-member LLC, you pay 15.3% SE tax (12.4% Social Security + 2.9% Medicare) on every dollar of net earnings up to the Social Security wage base ($168,600 in 2026), plus 2.9% Medicare on everything above that. A business netting $150,000 pays roughly $21,200 in self-employment tax — on top of income tax.

The upside: simplicity. No payroll to run, no separate corporate return, minimal compliance costs. For businesses netting under $60,000, the simplicity usually outweighs the tax savings of other structures.

S-Corporation

An S-Corp is a pass-through entity — profits flow to shareholders' personal returns and are taxed at individual rates. The key advantage: income splitting.

As an S-Corp owner, you split your business income into two buckets:

• Reasonable salary: Subject to payroll taxes (15.3% combined employer/employee share). You must pay yourself a salary that's comparable to market rates for the work you do.
• Distributions: The remaining profit passes through as distributions, which are not subject to self-employment or payroll tax. They're still subject to income tax.

Example: Your S-Corp nets $150,000. You pay yourself a reasonable salary of $70,000 and take $80,000 as distributions.

• Payroll tax on salary: $70,000 × 15.3% = $10,710
• Payroll tax on distributions: $0
• Total payroll/SE tax: $10,710

Compare that to the LLC's $21,200 in SE tax on the same $150,000. The S-Corp saves you roughly $10,490 per year. Over five years, that's more than $50,000.

The tradeoff: you must run payroll (cost: $500-$3,000/year through services like Gusto or ADP), file a separate corporate return (Form 1120-S, cost: $1,000-$2,500 at a CPA), and maintain corporate formalities. Your small business CPA should handle the S-Corp election paperwork and ongoing compliance.

C-Corporation

A C-Corp is a separate taxable entity. It pays corporate income tax at a flat 21% federal rate on profits. When those profits are distributed to shareholders as dividends, the shareholders pay tax again — this is the "double taxation" issue.

Effective tax rate on distributed C-Corp income:

• Corporate tax: 21%
• Remaining $79 of every $100 is distributed as qualified dividends
• Shareholder tax on dividends: 15-20% (plus 3.8% NIIT for high earners)
• Combined effective rate: 36.8%-39.8%

So why would anyone choose a C-Corp? Several scenarios make it advantageous:

When Each Entity Makes Sense

Choose an LLC (Default) When:

• Net business income is under $60,000-$80,000. The SE tax savings from an S-Corp don't justify the added compliance costs.
• You want maximum simplicity. No payroll, no corporate return, minimal bookkeeping requirements.
• You're testing a business idea. Start as an LLC and elect S-Corp treatment later when income justifies it.
• You have significant losses. LLC losses flow through to your personal return and can offset other income (subject to at-risk and passive activity rules).

Choose an S-Corp When:

• Net income consistently exceeds $80,000. This is the sweet spot where SE tax savings exceed the compliance costs.
• You can establish a reasonable salary. If your industry and role support a salary of $60,000-$100,000 and your business nets significantly more, the distribution strategy works.
• You want pass-through taxation without SE tax on all earnings. S-Corps combine the pass-through benefits of an LLC with the payroll tax savings of income splitting.
• You have fewer than 100 shareholders (S-Corp limit), all of whom are U.S. citizens or residents.

Choose a C-Corp When:

• You're seeking venture capital or plan to go public. Investors strongly prefer C-Corps for their familiar structure, stock classes, and equity incentive options.
• You plan to retain significant earnings in the business. If you're reinvesting profits rather than distributing them, the 21% corporate rate beats the top individual rate of 37%. A business retaining $500,000 in earnings saves $80,000 in tax at 21% vs. 37%.
• You want to offer equity compensation. C-Corps can issue Incentive Stock Options (ISOs), which provide favorable tax treatment for employees. S-Corps and LLCs are limited to NSOs or profit interests.
• You qualify for the Qualified Small Business Stock (QBSS) exclusion. Section 1202 allows C-Corp shareholders to exclude up to $10 million (or 10× their basis) in capital gains when selling stock held for 5+ years. This is one of the most powerful tax benefits in the code.

The S-Corp Election Process

You don't need to form a new entity to get S-Corp treatment. An existing LLC can elect S-Corp status by filing Form 2553 with the IRS:

1. File by March 15 of the year you want the election to take effect (or within 75 days of formation)
2. All members must consent to the election
3. Set up payroll immediately — you must pay yourself a reasonable salary from day one of the election
4. Begin filing Form 1120-S annually

Late elections are possible using the IRS's reasonable cause relief procedures, but it's easier to file on time. Your small business tax CPA can prepare and file Form 2553 as part of your tax planning engagement.

Common Mistakes to Avoid

Setting S-Corp Salary Too Low

The IRS scrutinizes S-Corp owners who pay themselves $30,000 salaries while taking $200,000 in distributions. The "reasonable salary" requirement is real, and the IRS has reclassified distributions as wages in audit, resulting in back payroll taxes, penalties, and interest. Work with your CPA to set a defensible salary based on industry comparables.

Electing S-Corp Too Early

If your business nets $40,000, the S-Corp compliance costs ($2,000-$4,000/year for payroll + corporate return) eat most of the tax savings. Wait until net income is consistently above $80,000.

Ignoring State Tax Implications

Some states impose separate taxes on S-Corps or C-Corps. California charges a 1.5% tax on S-Corp net income (minimum $800). New York City imposes an Unincorporated Business Tax on LLCs. State-level implications can swing the optimal entity choice — a CPA familiar with your state's rules is essential.

Choosing C-Corp Without a Clear Reason

Many business owners choose C-Corp because it "sounds professional." Unless you're raising venture capital, planning to retain large earnings, or qualifying for QBSS, a C-Corp usually results in higher total tax than a pass-through entity. The 21% rate looks attractive until you add the dividend tax layer.

The Bottom Line

For most small businesses: start as an LLC, elect S-Corp status when net income exceeds $80,000, and only consider C-Corp status if you're raising institutional capital or retaining substantial earnings. The decision is worth a $500-$1,000 consultation with a CPA specializing in entity structure — it will save you multiples of that in tax over the life of your business.