S-Corporation vs. LLC Taxation: What Business Owners Need to Know

Both S-corporations and LLCs are popular structures for small businesses because they generally provide liability protection and avoid double taxation. Income typically passes through to the owners' personal tax returns. However, the way that income is taxed—especially regarding self-employment taxes—can differ substantially between the two.

Default Tax Treatment

A single-member LLC is usually disregarded for tax purposes and reports income on the owner's Schedule C, just like a sole proprietorship. A multi-member LLC is treated as a partnership by default and files Form 1065.

An S-corporation, by contrast, is a corporation that has elected S status with the IRS. It files Form 1120-S and issues Schedule K-1s to shareholders. The key point is that both structures are generally pass-through entities, so business profits are taxed only once at the individual level.

Self-Employment Taxes: The Main Difference

The biggest tax distinction lies in how self-employment (or payroll) taxes apply.

With a default LLC, nearly all net business income is subject to self-employment tax—currently 15.3% (12.4% Social Security up to the annual wage base plus 2.9% Medicare). Owners pay this tax on their share of profits whether or not they actually withdraw the money from the business.

An S-corporation works differently. Shareholder-employees must pay themselves a reasonable salary, which is subject to payroll taxes. However, profits taken as distributions above that salary are generally not subject to self-employment tax. This structure can produce meaningful tax savings once business profits exceed the reasonable salary level.

Reasonable Compensation Requirement

S-corporations carry an extra rule that default LLCs do not: working shareholders must receive "reasonable compensation" for services they perform. The IRS can reclassify distributions as wages if the salary appears too low, which can trigger back taxes and penalties.

LLCs taxed as partnerships or sole proprietorships have no such salary requirement. All income simply flows through and is subject to self-employment tax.

Flexibility and Compliance

LLCs offer more structural flexibility. They can have different classes of ownership interests and more freedom in how profits and losses are allocated among members. Adding or removing owners is usually simpler.

S-corporations face stricter IRS rules, including a limit of 100 shareholders, a requirement that all shareholders be U.S. citizens or residents, and only one class of stock. They also carry more formal corporate requirements, such as bylaws and meeting minutes, plus the need to run payroll for working owners.

LLCs Electing S-Corp Status

Many business owners form an LLC and then elect to have it taxed as an S-corporation. This approach combines the liability protection and flexibility of the LLC legal form with the self-employment tax treatment of an S-corp. It is a common strategy when the self-employment tax savings justify the added payroll and compliance obligations.

Other Tax Items

Depreciation rules for equipment, vehicles, and other assets are largely the same under either pass-through structure. Section 179 expensing and 100% bonus depreciation (available in 2026 for qualifying property) apply similarly once the entity is treated as a pass-through.

Both structures can also qualify for the 20% Qualified Business Income deduction, though the presence of a required salary in an S-corp can affect how much income ultimately qualifies.

Bottom Line

For many profitable businesses where the owner actively works in the company, S-corporation taxation (or an LLC electing S status) can reduce self-employment taxes on distributions. For lower-profit businesses or situations where maximum flexibility and simplicity are priorities, a default LLC may be the better fit.

The right choice depends on profit levels, the owner's involvement in the business, and long-term plans. Tax laws are complex and state rules can vary. Business owners should consult a qualified tax professional to evaluate which structure best fits their specific situation.