LLC vs. S-Corp vs. C-Corp: Complete Tax Comparison for Small Businesses

Legal structure vs. tax election:

Legal structures (state law):

• Sole proprietorship: no formal entity. The owner IS the business. No liability protection.
• LLC (Limited Liability Company): a state-level entity that provides liability protection. Members’ personal assets are generally protected from business debts.
• Corporation: a state-level entity with shareholders, directors, and officers. Strongest liability protection. More formalities (bylaws, minutes, annual meetings).

Tax elections (IRS):

• Disregarded entity (default for single-member LLC): taxed like a sole proprietorship (Schedule C)
• Partnership (default for multi-member LLC): taxed on Form 1065, K-1 to members
• S-Corporation (election via Form 2553): taxed on Form 1120-S, K-1 to shareholders. Reduces SE tax on distributions.
• C-Corporation (default for corporations, or elected via Form 8832): taxed on Form 1120. Corporate-level tax at 21%. Dividends taxed again to shareholders (double taxation).

The common path for small businesses:

1. Start as sole proprietorship (simplest, no filing)
2. Form an LLC when liability protection is needed
3. Elect S-Corp taxation (Form 2553) when net profit exceeds $50,000-$70,000 (SE tax savings justify the compliance cost)
4. Consider C-Corp ONLY for businesses seeking QSBS exclusion (IRC 1202), outside investors, or retained earnings taxed at the 21% corporate rate

Comparison at $120,000 net profit (single filer):

Sole prop / single-member LLC (disregarded):

• SE tax: $16,946
• Income tax: approximately $10,100
• QBI deduction: $24,000
• Total tax: $27,046
• Compliance cost: $0-$500 (Schedule C on personal return)

LLC taxed as S-Corp:

• Reasonable salary: $55,000
• Employer FICA: $4,208
• Employee FICA: $4,208
• K-1: $60,792
• Income tax: approximately $12,000
• QBI on K-1: $12,158
• Total tax: $20,416
• Compliance cost: $2,000-$3,500 (payroll + S-Corp return)
• Net savings vs. sole prop: $4,130

C-Corp:

• Corporate income: $120,000
• Corporate tax (21%): $25,200
• If all remaining profit is distributed as salary: FICA applies
• If distributed as dividends: qualified dividend rate (15-20%)
• Assuming $60,000 salary, $34,800 in dividends:
  • Salary FICA (employer + employee): $9,180
  • Corporate tax on remaining $60,000 - $4,590 employer FICA = $55,410 x 21% = $11,636
  • Dividend tax: ($55,410 - $11,636) x 15% = $6,566
  • Personal income tax on salary: approximately $5,000
  • Total tax: approximately $32,382
• Compliance cost: $2,000-$4,000
• MORE expensive than sole prop by $5,336

The C-Corp is more expensive at $120,000 net profit due to double taxation. The C-Corp becomes advantageous ONLY when:

1. QSBS exclusion applies (eliminating capital gains tax on an eventual sale, saving $200,000+ on a $1 million exit)
2. The business retains earnings at the 21% corporate rate (lower than the owner’s personal rate of 32%+)
3. Outside investors require corporate structure