When starting a business, choosing the right legal structure can significantly impact how much you pay in taxes, your personal liability, and your compliance responsibilities. Two of the most popular choices for small business owners are the Single-Member LLC and the S-Corporation (S-Corp). Each has its own pros and cons when it comes to taxes.
Let’s break down the tax pros and cons to help you avoid costly tax preparation errors, no matter which business structure you pick.
Single-Member LLC: The Simpler Path
A Single-Member LLC (SMLLC) is a limited liability company with only one owner. For tax purposes, it’s considered a “disregarded entity,” meaning the IRS ignores the LLC structure and treats it as a sole proprietorship by default.
Pros:
- Simplicity in Filing
- A single-member LLC is considered a “disregarded entity” by the IRS. That means it’s taxed like a sole proprietorship.
- You report business income and expenses on Schedule C of your personal tax return (Form 1040).
- Pass-Through Taxation
- No separate business tax return filing required.
- Profits pass through directly to the owner and are taxed at the individual level, avoiding double taxation.
- Fewer Compliance Requirements
- Minimal annual paperwork.
- No need to run payroll (unless you have employees).
- Flexible Expense Deductions
- You can still deduct ordinary and necessary business expenses like a home office, vehicle use, and more.
Cons:
- Self-Employment Tax Can Be High
- You pay 15.3% on net income for Social Security and Medicare, which adds up fast.
- No Salary Division
- All profit is subject to self-employment tax. You can’t split income between salary and distributions as you can with an S-Corp.
S-Corporation: The Tax Strategy Move
An S-Corporation is a tax election, not a business structure. You can be an LLC and elect to be taxed as an S-Corp by filing Form 2553 with the IRS. The business still offers liability protection, but income is treated differently.
Pros:
- Potential Tax Savings
- You can pay yourself a reasonable salary and take the remaining profit as dividends/distributions, which aren’t subject to self-employment tax.
- Still a Pass-Through Entity
- No corporate income tax, profits flow through to the owners/shareholders and are reported on your personal return (on Schedule E).
- More Credibility
- Some clients and vendors see incorporated businesses as more established.
Cons:
- More Paperwork & Compliance
- Must file Form 1120-S annually and issue W-2s for any salaries.
- You’ll need to run payroll, maintain corporate bylaws, and conduct annual meetings.
- Reasonable Salary Requirement
- The IRS requires that you pay yourself a “reasonable” salary, which can be subjective and invites scrutiny.
- State-Level Costs
- Some states charge extra fees or taxes on S-Corps (like California’s $800 minimum franchise tax).
So, Which One Should You Choose?
It depends on:
- Your net profit level (S-Corp savings usually start to make sense around $40K–$50K net income).
- Your ability to handle (or outsource) the extra admin involved in an S-Corp.
- Whether you plan to reinvest profits or take home most of your income.
Pro Tip:
You can start as an LLC and elect S-Corp status later by filing IRS Form 2553, often a good strategy for growing businesses.
Example Scenario
Let’s say your business earns $100,000 in profit:
- As a Single-Member LLC, you’d pay self-employment tax (15.3%) on the full $100,000.
- As an S-Corp, if you pay yourself a $60,000 salary and take $40,000 as a distribution, you only pay payroll tax on $60,000. The $40,000 is not subject to self-employment tax, potentially saving over $6,000 in taxes.
Conclusion
Choosing between a Single-Member LLC and an S-Corporation is a crucial decision that can significantly impact your tax obligations, compliance requirements, and take-home income. While the LLC offers simplicity and flexibility, the S-Corp can unlock powerful tax savings with the right setup and ongoing compliance.
For small business owners who want to ensure they’re making the most tax-efficient choice, professional guidance is essential. Alpha Accounting specializes in providing outsourced tax preparation services tailored specifically for CPAs and accounting firms. If you have questions about structuring your business or want expert support with compliance, payroll, or tax planning, consult Alpha Accounting for reliable, expert-backed solutions.