What Is the Best Business Structure for Taxes?
Bizee breaks down how each business structure — sole proprietorship, partnership, LLC, S Corp, and C Corp — affects your taxes, self-employment obligations, and IRS filing requirements.
Bizee Editorial Staff
Editorial Team
Introduction
It depends on your income, how you pay yourself, and how much self-employment tax you want to manage. Sole proprietorships and partnerships are the simplest, but they come with the full 15.3% self-employment tax. LLCs, S Corps, and C Corps each offer different trade-offs between tax savings, filing complexity, and liability protection.
How business structure affects your taxes
Your business structure determines whether income is taxed at the entity level or passes through to your personal return, which IRS forms you file, and how much self-employment tax you owe. It also affects what deductions you can take and how you pay yourself.
The core split is between pass-through entities and C corporations. Pass-through entities — sole proprietorships, partnerships, LLCs, and S Corps — don't pay federal income tax at the entity level. Income flows to the owners' personal returns and gets taxed at individual rates, which can reach up to 37%. C corporations pay a flat 21% corporate tax rate, but shareholders also pay tax on any dividends they receive — that's the double taxation trade-off.
Most small business owners are better served by a pass-through structure — the question is which one fits their income level and how they want to handle self-employment taxes.
Sole proprietorship and partnership taxes
Sole proprietorships and partnerships are the default structures for unincorporated businesses. They're the simplest to run, but they carry the full weight of self-employment tax — 15.3% on net earnings — on top of regular income tax.
Sole proprietorship
A sole proprietorship isn't a separate tax entity. All business income and expenses go on your personal Form 1040 via Schedule C. You pay federal income tax at your individual rate on net profit, plus the 15.3% self-employment tax on net earnings of $400 or more. You can deduct half of that self-employment tax as an adjustment to income, which softens the hit slightly.
Partnership
Partnerships file Form 1065 with the IRS and issue a Schedule K-1 to each partner showing their share of income, deductions, and credits. Partners then report that income on their personal returns. General partners pay self-employment tax on their share of net income. Limited partners generally don't, though the rules get nuanced depending on how active they are in the business.
LLC tax treatment and election options
An LLC doesn't have its own federal tax classification by default — the IRS taxes it based on how many members it has, unless you file to change that. This flexibility is one of the reasons LLCs are the most popular structure for small business owners.
Single-member LLC
By default, the IRS treats a single-member LLC as a disregarded entity — meaning it's taxed exactly like a sole proprietorship. You report income and expenses on Schedule C of your personal Form 1040 and pay self-employment tax on net earnings.
Multi-member LLC
A multi-member LLC is taxed as a partnership by default. The LLC files Form 1065 and issues Schedule K-1s to each member. Members pay self-employment tax on their share of net income.
LLC tax elections
An LLC can elect to be taxed as a C corporation by filing IRS Form 8832. To be taxed as an S corporation, you file Form 8832 first (if needed) and then Form 2553. The S Corp election is the one most small business owners consider when their net income is high enough that the self-employment tax savings outweigh the added complexity of running payroll.
S Corp taxes: the salary and distribution split
An S corporation is a pass-through entity — income, deductions, and credits flow to shareholders' personal returns via Schedule K-1, and the S Corp itself pays no federal income tax. The tax advantage comes from how owner-employees get paid.
Owner-employees of an S Corp must pay themselves a reasonable salary as a W-2 employee. That salary is subject to payroll taxes. But any remaining profit distributed to shareholders is not subject to self-employment tax — that's where the savings come from. If your business nets $150,000 and you pay yourself a $80,000 salary, only the $80,000 is subject to payroll taxes. The distribution on the remaining $70,000 is not.
To qualify, the business must be a domestic corporation with no more than 100 shareholders, all of whom must be individuals, certain trusts, or estates — not other corporations or partnerships. The S Corp election is made by filing Form 2553, signed by all shareholders. The S Corp files Form 1120-S annually.
C Corp taxes: the 21% rate and double taxation
A C corporation is the only business structure that pays federal income tax at the entity level. The rate is a flat 21% on taxable income. That's lower than the top individual rate of 37%, which is why some high-earning businesses find C Corp status worth considering.
The trade-off is double taxation. The C Corp pays 21% on its profits. When it distributes dividends to shareholders, those dividends are taxed again at the shareholder's individual rate — 0%, 15%, or 20% for qualified dividends, depending on income. The C Corp files Form 1120 to report income and pay corporate tax before any distributions go out.
C Corps make the most sense for businesses planning to raise outside investment, retain earnings inside the business rather than distributing them, or eventually pursue an IPO. For most small business owners who want to take profits out regularly, the double taxation makes a pass-through structure more efficient.
How to change your business structure with the IRS
The IRS lets you change your business's tax classification by filing the right forms. The process depends on what you're changing from and what you're changing to.
To elect C corporation tax treatment for an LLC: file Form 8832 (Entity Classification Election)
To elect S corporation tax treatment for an LLC: file Form 8832 first (if needed), then Form 2553 (Election by a Small Business Corporation)
To convert an LLC to a corporation at the state level: the process varies by state and may require forming a new entity or filing a conversion document with your Secretary of State
Changing your tax classification can trigger real consequences — including recognizing gain on appreciated assets or losing favorable tax treatment — so talk to a tax professional before filing. The IRS forms handle the federal tax side, but state-level changes to your legal entity structure are a separate process.
Choosing the best structure for your tax situation
There's no single best structure — the right answer depends on your net income, how you want to pay yourself, and how much administrative complexity you're willing to take on. The structure that saves the most in taxes isn't always the one that's easiest to run.
Low income or just starting out
A sole proprietorship or single-member LLC taxed as a disregarded entity keeps things simple. You file Schedule C with your personal return. The self-employment tax is the main cost, but at lower income levels the savings from a more complex structure don't justify the added overhead.
Growing income where self-employment tax is a real cost
An S Corp election starts making sense when your net profit is high enough that the self-employment tax savings on distributions outweigh the cost of running payroll and filing Form 1120-S. Many tax professionals point to net profit around $40,000–$50,000 as the range where it's worth running the numbers. A tax professional can help you figure out the crossover point for your situation.
Raising investment or retaining earnings in the business
A C corporation is worth considering if you plan to bring in outside investors, issue multiple classes of stock, or keep profits inside the business rather than distributing them. The 21% flat corporate rate can be an advantage when earnings stay in the business. But if you're pulling profits out as dividends, double taxation erases much of that benefit.
Bizee does not provide tax or legal advice. This guide is for informational purposes only. Before changing your business structure or making a tax election, talk to a tax professional who can look at your specific numbers.
FAQ
It depends on your income and goals. For most small business owners with growing net profit, an S corporation election offers the best tax efficiency — you pay payroll taxes only on your salary, not on distributions. At lower income levels, a sole proprietorship or single-member LLC keeps things simple without the overhead. C corporations have a flat 21% rate but create double taxation when you take profits out.
It depends on your net profit. An LLC taxed as a disregarded entity or partnership is simpler, but all net income is subject to self-employment tax at 15.3%. An S Corp lets you split income between a salary (subject to payroll taxes) and distributions (not subject to self-employment tax), which can reduce your tax bill. The S Corp election makes more sense as net profit grows — many tax professionals suggest running the numbers once you're netting around $40,000–$50,000 or more.
Generally, pass-through structures — sole proprietorships, partnerships, LLCs, and S Corps — pay less in total tax for most small business owners because income is only taxed once. Among pass-through structures, an S Corp can reduce self-employment taxes by splitting income between salary and distributions. C corporations pay a flat 21% corporate rate, but shareholders also pay tax on dividends, so the combined tax burden is often higher for owners who take profits out regularly.
The IRS recognizes 4 tax treatments for an LLC: disregarded entity (single-member, taxed like a sole proprietorship), partnership (multi-member default), C corporation (elected via Form 8832), and S corporation (elected via Form 8832 and Form 2553). The default treatment applies automatically based on the number of members unless you file to change it.
The main business structures in the U.S. are sole proprietorship, general partnership, limited partnership, LLC, S corporation, and C corporation. Each has different rules for taxation, liability, and ownership. Sole proprietorships and general partnerships are the simplest but offer no liability protection. LLCs combine liability protection with flexible tax treatment. S Corps and C Corps are formal corporate structures with stricter IRS requirements and their own filing obligations.
File the appropriate IRS form for the election you want. To change an LLC to C corporation tax treatment, file Form 8832. To elect S corporation status, file Form 2553 (and Form 8832 first if your LLC needs to be reclassified). Changing your tax classification can have real consequences — including recognizing gain on appreciated assets — so talk to a tax professional before filing. State-level structural changes are a separate process from the IRS election.
