Quick orientation

Choosing between an LLC, S Corp, and C Corp affects taxes, owner liability, compliance burden, and growth options. Below I explain the tax mechanics that matter most in 2025, show practical decision points, and link to deeper resources so you can take the next step with a CPA or corporate attorney.

Note: This is educational information, not personalized tax or legal advice. Consult a licensed CPA or attorney before changing entity type.

How the tax rules differ (plain language)

  • LLC (default): A limited liability company provides personal-asset protection from most business liabilities and is tax-flexible. By default, single-member LLCs are treated as sole proprietorships and multi-member LLCs as partnerships for federal tax purposes; both are pass-through entities (income flows to owners’ individual returns). An LLC can elect to be taxed as an S corporation or C corporation if advantageous. (IRS: Limited Liability Company (LLC)) (https://www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-llc)

  • S Corporation (S Corp): An S Corp is a tax election (not a state-level formation) that makes a corporation (or eligible LLC) a pass-through entity for federal tax purposes. Profits and losses pass to shareholders and are reported on their personal returns, typically via Schedule K-1. Owners who work in the business must be paid a “reasonable salary”; payroll taxes apply to salary but not to distributions—this is where potential self-employment tax savings can arise. There are strict eligibility rules (e.g., up to 100 eligible shareholders). (IRS: S Corporations) (https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations)

  • C Corporation (C Corp): A C Corp is taxed as a separate entity. The corporation files Form 1120 and pays corporate income tax (currently a flat 21% at the federal level as of 2025). If the company distributes dividends, shareholders pay tax again—this is commonly called double taxation. C Corps are often used by companies seeking outside investors, multiple classes of stock, or to retain earnings for growth. (IRS: C Corporations) (https://www.irs.gov/businesses/small-businesses-self-employed/c-corporations)

Key decision factors (practical)

  1. Revenue and owner compensation
  • If you expect modest income and want simple reporting, an LLC taxed as a sole proprietor or partnership is often easiest.
  • If profits grow and the owner can split compensation into a reasonable salary plus distributions, electing S Corp treatment may reduce payroll taxes—but only if the salary is defensible. The IRS scrutinizes unreasonably low salaries. (IRS guidance on reasonable compensation applies.)
  1. Growth and fundraising
  • If you expect to seek venture capital, accept foreign investors, or want multiple stock classes, C Corp status is usually the standard choice.
  • S Corps limit shareholders (generally 100) and require eligible shareholder types, which can block some funding paths.
  1. Retained earnings vs distributions
  • C Corps let you retain earnings inside the business at corporate rates, which can be efficient for growth-focused firms.
  • Pass-through entities (LLC/S Corp) distribute income to owners, where it is taxed on individual returns (and may qualify for the Qualified Business Income (QBI) deduction under Section 199A, subject to limits). Check current QBI rules and limits for 2025 before planning. (IRS: QBI guidance) (https://www.irs.gov/)
  1. Administrative cost and complexity
  • S Corps and C Corps require payroll, formalities (minutes, bylaws), and stricter recordkeeping. LLCs have fewer required formalities in many states.

How elections work (forms and timing)

  • Elect S Corp: File Form 2553 (Election by a Small Business Corporation). The company must meet eligibility rules and timely file—generally by March 15 for calendar-year corporations, or within 75 days of formation for new entities. (IRS: Form 2553) (https://www.irs.gov/forms-pubs/about-form-2553)

  • Elect C Corp (or default to C Corp): If you form a corporation and do nothing, it is a C Corp by default. If an LLC wants corporate tax treatment, it files Form 8832 to elect to be treated as a corporation for tax purposes and then can file Form 2553 to become an S Corp if eligible. (IRS: Form 8832) (https://www.irs.gov/forms-pubs/about-form-8832)

  • Reporting: S Corps file Form 1120-S and issue Schedule K-1s to shareholders; C Corps file Form 1120. LLCs taxed as partnerships file Form 1065 and provide K-1s to members; single-member LLCs report on Schedule C (Form 1040) unless other elections are made.

Simple numerical illustration (illustrative only)

Imagine a single-owner business with $150,000 net profit after expenses:

  • LLC taxed as sole proprietor: Entire $150,000 is subject to income tax plus self-employment tax (Social Security and Medicare) on most of the profit (subject to Social Security wage base limits). Self-employment taxes can be ~15.3% on the earnings taxed for Social Security/Medicare.
  • S Corp (owner-employee): Owner pays themselves a reasonable salary—say $80,000—subject to payroll taxes; remaining $70,000 is distributed as a dividend not subject to payroll taxes. This structure can reduce payroll-tax exposure, but you must handle payroll, withholdings, and comply with reasonable compensation rules.
  • C Corp: Company pays 21% corporate tax on taxable income. If after-tax profits are distributed as dividends, shareholders pay tax on those dividends as well—creating double taxation. However, if profits are retained to grow the business, C Corp can be more efficient.

These figures are illustrative—not a substitute for running your financials with a tax adviser.

When to choose each structure (practical triggers)

  • Choose or keep an LLC if: you want liability protection with simple pass-through taxation, you have one or a few owners, and you prefer low administrative overhead.

  • Consider S Corp election if: your business generates consistent profits and you (and other active owners) can justify a reasonable wage plus distributions that yield payroll-tax savings after accounting for increased compliance costs.

  • Choose C Corp if: you plan to raise institutional capital, need different classes of stock, want foreign or corporate shareholders, or intend to retain earnings to fund growth.

Common mistakes to avoid

  • Treating S Corp distributions as a substitute for reasonable salary (IRS audits often target low salary/high distribution situations).
  • Failing to file an S election on time and assuming you can retroactively claim benefits without IRS relief.
  • Ignoring state-level taxes and fees—some states impose franchise taxes or minimum taxes on corporations and LLCs.
  • Not considering payroll, unemployment, and payroll tax filing costs if you elect S Corp treatment.

Step-by-step decision checklist

  1. Project three years of revenue and owner compensation scenarios.
  2. Estimate federal and state income and payroll taxes under each entity type.
  3. Evaluate capital needs (will you seek outside investors?).
  4. Check ownership restrictions (S Corp limits, foreign owners, corporate shareholders).
  5. Consider administrative bandwidth and compliance costs.
  6. Run the numbers with a CPA and confirm state filing requirements and fees.

If you want a practical guide to next steps, start with our broader planning map: Entity Selection Roadmap: When to Use an LLC, Corporation or Trust.

For a deeper comparison of tax differences, see our article: S Corporation vs. C Corporation: Tax Differences and Choosing the Right Structure.

If you need more detail about LLC taxes and how they interact with liability planning, read: Limited Liability Company (LLC).

Real-world perspective (what I see in practice)

In my work advising small businesses, I commonly see three patterns:

  • Very small solo operators keep an LLC taxed as a sole proprietorship because the simplicity outweighs small tax savings.
  • Growing service businesses often elect S Corp treatment once profit levels make payroll-tax planning worthwhile, but only after modeling reasonable salaries and compliance costs.
  • Companies aiming for VC funding or IPOs incorporate as C Corps early, accepting corporate-level tax and formalities in exchange for investor-friendly structure.

One realistic warning: the S Corp tax advantage is not automatic. It requires documentation, payroll, and a defensible compensation policy. I once helped a client switch to S Corp treatment mid-year; we documented compensation benchmarks and payroll to satisfy IRS expectations and saved the owner several thousand dollars in payroll tax—after factoring in accounting and payroll costs.

Final takeaway and next steps

Entity choice ties together taxes, liability protection, and long-term strategy. If you are forming a new business, map out ownership, funding needs, and compensation plans before choosing. If your business is already operating, run a prospective three-year tax and cash-flow comparison under each structure and consult a CPA. Small changes in revenue or owner pay can make one form materially better than another.

Professional disclaimer: This article is educational and reflects general principles current in 2025. It does not replace advice from a licensed tax professional or attorney who understands your facts. Contact a CPA or business attorney to model outcomes for your specific situation.