S Corporation vs LLC vs Sole Proprietor | Taxtical Guide
Introduction: Choosing the Right Business Structure
Selecting the right business entity—S Corporation (S Corp), LLC, or Sole Proprietorship—can significantly impact your taxes, liability, and long-term growth. This guide explains how S Corporations work, their benefits and drawbacks, and how they compare to other popular structures.
What is an S Corporation?
An S Corporation (S Corp) is a special tax classification granted by the IRS that allows corporations or LLCs to avoid double taxation. Instead of the business paying taxes on profits, income "passes through" to shareholders’ personal tax returns.
Key Features of an S Corporation
Pass-through taxation (profits taxed only at shareholder level)
Limited liability protection for owners
Up to 100 shareholders, all must be U.S. citizens or residents
One class of stock only
Must file IRS Form 2553 to elect S Corp status
How Does an S Corporation Work?
To become an S Corp, a business must first form a corporation or LLC and then file Form 2553 with the IRS.
How S Corp Taxation Works
- Profits/losses are passed to shareholders' personal tax returns.
- No federal corporate income tax (though some states may impose one).
- Shareholder-employees must be paid a reasonable salary, subject to payroll taxes.
Benefits of an S Corporation
✅ Avoids double taxation
✅ Reduces self-employment taxes through salary/distribution strategy
✅ Limited liability for shareholders
✅ Perpetual existence
✅ Enhanced credibility with banks and investors
Drawbacks of an S Corporation
❌ Strict IRS requirements and eligibility limitations
❌ 100 shareholder limit
❌ Only U.S. citizens/residents can be shareholders
❌ More complex filing and record-keeping
❌ Must pay shareholder-employees a reasonable wage
S Corporation vs LLC: What’s the Difference?
| Feature | S Corporation | LLC |
|---|---|---|
| Taxation | Pass-through (no double tax) | Default pass-through; can elect S Corp |
| Self-employment tax savings | Salary taxed; distributions not | All income may be subject to SE tax |
| Ownership Rules | U.S. individuals only (max 100) | Flexible ownership allowed |
| Stock options | One class only | Not applicable |
| Compliance | High (meetings, minutes, payroll) | Moderate |
| Management structure | Directors + Officers | Flexible |
➡️ LLCs offer flexibility, while S Corps can save money on self-employment taxes for profitable businesses.
S Corporation vs Sole Proprietor: Which is Right for You?
| Feature | S Corporation | Sole Proprietor |
|---|---|---|
| Legal entity | Separate legal entity | Not separate (personal and business are one) |
| Liability protection | Yes | No |
| Tax filing | Business files separately (Form 1120S + K-1s) | Schedule C on personal return |
| Self-employment taxes | May reduce via salary/distribution split | Pays SE tax on all net income |
| Startup Costs | Higher (incorporation + filings) | Low or none |
| Compliance | High | Low |
➡️ Sole proprietorships are simple but risky. S Corps require more effort but offer protection and potential tax savings.
Should You Choose an S Corporation?
You should consider forming an S Corporation if:
Your business is profitable and consistent
You want to reduce self-employment taxes
You're comfortable with extra compliance
You're a U.S. citizen or resident
You don't need multiple stock classes or foreign investors
How to Form an S Corporation (Step-by-Step)
- Form a Corporation or LLC with your state.
- Apply for an EIN (Employer Identification Number) from the IRS.
- File IRS Form 2553 within 2.5 months of incorporation (or by March 15 for existing businesses).
- Comply with ongoing payroll, tax, and corporate governance requirements.
Conclusion
An S Corporation can be a smart choice for small business owners looking to minimize taxes while enjoying liability protection. However, it comes with eligibility rules and extra compliance steps. Before making a decision, consult a tax advisor or accountant to assess what’s best for your unique situation.
Need Help Setting Up an S Corporation?
At Taxtical, we help small business owners:
Incorporate or form LLCs
Elect S Corporation status
Stay compliant year-round
📞 Contact us today for a free consultation and get expert help setting up your S Corporation.
FAQs About S Corporations
❓ Can an LLC be taxed as an S Corp?
✅ Yes. You can file Form 2553 to elect S Corp taxation for your LLC.
❓ What is the deadline to elect S Corp status?
✅ File Form 2553 within 2.5 months of business formation or by March 15 for existing businesses.
❓ Can S Corporations have employees?
✅ Yes. Shareholders who work for the S Corp must be treated as employees and paid a reasonable salary.