When it comes to running a business, choosing the right structure is one of the most important decisions you can make. Your business structure impacts liability protection, management flexibility, and, most importantly for our purposes, taxes. Two popular options for small business owners are the Limited Liability Company (LLC) and the S Corporation (S-Corp). While both can provide liability protection and pass-through taxation, there are significant differences that could impact how much you pay in taxes each year.

In this blog, we’ll break down the differences between LLCs and S-Corps, explain how taxes work for each, and provide guidance on which structure might be best for your business.

 

What is an LLC?

An LLC, or Limited Liability Company, is a flexible business structure that combines the liability protection of a corporation with the simplicity of a partnership. LLC owners, also known as members, are generally not personally liable for the company’s debts and liabilities. This means your personal assets, like your home or savings, are typically protected if the business faces legal or financial issues.

From a tax perspective, LLCs are considered pass-through entities. This means that the business itself does not pay federal income tax. Instead, profits and losses “pass through” to the owners, who report them on their personal tax returns.

For a single-member LLC, this is straightforward: the business’s income is reported on Schedule C of your personal tax return. For multi-member LLCs, the business files Form 1065, and each member receives a Schedule K-1 showing their share of profits and losses.

One of the benefits of an LLC is simplicity. There are no special payroll requirements for members, since they are not considered employees for their own services. However, if the LLC hires employees, regular payroll requirements apply just like with any other business.

It’s also important to note that trade or business income allocated to LLC members is generally subject to self-employment tax (covering Social Security and Medicare), but there are exceptions—for example, certain rental income or members treated more like limited partners.

 

What is an S-Corp?

An S-Corp is not a separate type of legal entity. Instead, it’s a federal tax election that an LLC or corporation can make with the IRS. In other words, you may still be an LLC, partnership, or C-Corp that chooses to be taxed as an S-Corp.

Like an LLC, an S-Corp generally does not pay federal income tax at the corporate level. Instead, profits and losses pass through to shareholders, who report them on their personal tax returns.

Where the S-Corp can differ significantly from an LLC is in how payroll and distributions are handled. S-Corp owners who actively work in the business must pay themselves a “reasonable salary” for their work. This salary is subject to payroll taxes, but additional profits can be taken as distributions (not dividends, unless the business has C-corp earnings and profits). These distributions are not subject to self-employment tax, which can result in meaningful tax savings.

For example, if your S-Corp earns $150,000 in net profit and you pay yourself a $70,000 reasonable salary, you only pay payroll taxes on the $70,000. The remaining $80,000 can be taken as distributions without additional payroll tax, potentially saving thousands in taxes.

 

Key Tax Differences Between LLCs and S-Corps

Self-Employment Taxes

• LLC members generally owe self-employment tax on all business earnings (with exceptions noted earlier).
  
• S-Corp owners only owe payroll taxes on their reasonable salary, while distributions are not subject to self-employment tax.

Tax Filings & Administration

• LLCs are simpler: single-member LLCs file on Schedule C, while multi-member LLCs use Form 1065.
  
• S-Corps must file Form 1120S, run payroll, and issue W-2s, which adds administrative complexity.
  

Payroll

• LLC members aren’t employees for their own services (no payroll for themselves), but regular payroll applies to employees.
  
• S-Corp owner-employees must pay themselves a reasonable salary and follow payroll rules.
  

Owner Benefits

• S-Corps don’t necessarily offer more flexibility. In fact, owner-employees who own more than 2% of an S-Corp face limits on fringe-benefit exclusions. For example, health insurance premiums must be included in wages and handled with special rules.
  

Profit Distribution

• LLCs can allocate profits however the operating agreement allows.
  
• S-Corps must distribute profits strictly based on ownership percentages.
  

State-Level Taxes

• Illinois: Partnerships and S-Corps owe the Personal Property Replacement Tax at 1.5% of net Illinois income (Illinois Department of Revenue).
• California: Most entities (LLCs, corporations, S-corps) owe an $800 annual franchise/minimum tax. The temporary first-year waiver has expired. 

Who Benefits Most from an LLC?

LLCs are often ideal for business owners who value simplicity, flexibility, and lower administrative costs. They work especially well for entrepreneurs just starting out who want a straightforward structure without the burden of heavy compliance.

An LLC can also be a good fit when business income is modest and self-employment taxes remain manageable. The structure allows owners to decide how profits are allocated, offering more flexibility than other entities. Additionally, LLCs require fewer formalities and reporting obligations, making them attractive for those who prefer a low-maintenance option.

Single-member businesses, in particular, often benefit from an LLC. Tax filing is relatively simple, and payroll is not required unless the owner hires employees. This combination of ease and flexibility makes LLCs a popular choice for small business owners.

 

Who Benefits Most from an S-Corp?

S-Corps can be especially advantageous for business owners with higher net income who are actively involved in running their business. The primary appeal lies in the potential savings on self-employment taxes, though these benefits come with added responsibilities.

An S-Corp is often a good fit if you expect your business to generate profits well above what you would reasonably pay yourself as a salary. It also works well for owners who are prepared to manage payroll or outsource it to a professional service. For those aiming to maximize tax efficiency while still enjoying the advantages of pass-through taxation, an S-Corp can be a strong option.

That said, S-Corps require comfort with stricter reporting obligations and corporate formalities. They tend to be particularly useful for businesses in consulting, professional services, and other industries where the owner’s active involvement drives significant profits. By structuring compensation as a mix of salary and distributions, owners may reduce their overall tax liability while staying compliant with IRS rules.

 

Common Misconceptions

• “An S-Corp is its own entity type.”
  Not true—an S-Corp is a tax election, not a legal entity.
  
• “All LLC profits are subject to self-employment tax.”
  Generally true, but with exceptions like rental income or limited-partner-type members.
  
• “LLCs don’t pay taxes.”
  While LLCs benefit from pass-through taxation, members still owe income and self-employment taxes on their share of profits.
  
• “S-Corps provide better fringe benefits for owners.”
  Not exactly—2% S-Corp shareholder-employees face special restrictions on benefits such as health insurance.

 

Partnering with Tavola Group

Choosing between an LLC and an S-Corp isn’t just about taxes, it’s about balancing compliance, growth, and financial goals. At Tavola Group, we help business owners model scenarios, maximize tax efficiency, and plan for long-term success.

Small details can have a big impact on your tax outcome, and professional guidance can save time, reduce risk, and uncover savings. We provide everything you need so you can make confident decisions for your business. Book a free tax planning consultation today and take the first step toward optimizing your business for growth, efficiency, and savings.