In this article
Last updated: May 27, 2026 · Reading time: 8 minutes
A sole proprietorship is the simplest and free, but gives you no liability protection. An LLC adds personal liability protection for a small state fee and is the right default for most small businesses. An S-corp is a tax election (usually layered on an LLC) that can cut self-employment tax once your net profit is consistently above roughly $40,000–$80,000 — but it adds payroll and accounting costs. Most owners start as a sole prop or LLC and elect S-corp status later when the savings outweigh the extra paperwork.
These are two different decisions
People lump these together, but there are really two questions:
- Legal structure: sole proprietorship vs LLC vs corporation. This is about liability and how you register.
- Tax treatment: default pass-through vs S-corp election. This is about how you're taxed, and an LLC can choose either.
An LLC taxed as an S-corp is extremely common — it's not "LLC vs S-corp," it's "LLC, taxed as an S-corp."
Side-by-side comparison
| Sole Proprietor | LLC | LLC + S-Corp election | |
|---|---|---|---|
| Setup cost | $0 | $50–$500 state fee | LLC fee + payroll/accounting |
| Liability protection | ❌ None | ✅ Yes | ✅ Yes |
| Tax complexity | Simplest (Schedule C) | Same as sole prop by default | Higher — payroll + 1120-S return |
| Self-employment tax | On all net profit | On all net profit | Only on your "reasonable salary" |
| Best for | Brand-new, low-risk side businesses | Most established small businesses | Consistent profit above ~$40k–$80k |
How the S-corp tax savings actually work
As a sole proprietor or default LLC, you pay 15.3% self-employment tax on all your net profit. With an S-corp election, you split your profit into two buckets:
- A "reasonable salary" you pay yourself through payroll — this is subject to the 15.3% payroll taxes.
- The remaining profit as a distribution — this is not subject to self-employment tax.
Example: $100,000 net profit. Pay yourself a $60,000 reasonable salary; take $40,000 as a distribution. You save the 15.3% SE tax on that $40,000 — roughly $6,000/year. Subtract payroll service and extra accounting costs (~$1,500–$3,000/year), and the net savings is real but only worth it above a certain profit level.
Rule of thumb: the S-corp election usually starts paying off once net profit is reliably above $40,000–$80,000. Below that, the added cost and complexity outweigh the savings. The "reasonable salary" must be genuinely reasonable for your role — the IRS scrutinizes artificially low salaries.
What most owners should do
- Just starting / testing an idea: sole proprietor. Zero cost, simplest taxes. Upgrade later.
- Established, has customers, owns assets or has liability exposure: form an LLC for the liability protection.
- LLC consistently netting more than ~$40k–$80k: talk to a CPA about electing S-corp status to cut SE tax.
You can move up this ladder as you grow. You don't have to get it perfect on day one.
Frequently asked questions
Should I form an LLC or stay a sole proprietor?
Form an LLC if you want personal liability protection — it keeps your personal assets (home, savings) separate from business debts and lawsuits. Stay a sole proprietor only for very low-risk, early-stage, or side businesses where that protection isn't yet worth the state filing fee.
At what income should I switch to an S-corp?
There's no fixed line, but the S-corp election commonly starts paying off when net profit is reliably above $40,000–$80,000, because the self-employment-tax savings then exceed the added payroll and accounting costs. Confirm with a CPA for your situation.
Does an LLC save me money on taxes?
By itself, no — a single-member LLC is taxed exactly like a sole proprietorship by default. The tax savings come from electing S-corp status, which an LLC can do. The LLC's main benefit is liability protection, not tax savings.
Can I change my business structure later?
Yes. Many owners start as a sole proprietor, form an LLC as they grow, and elect S-corp taxation once profit justifies it. Each step is a manageable filing.
Sole prop, LLC, or S-corp — you still need clean books and tax-ready reports. Daily Invoice Maker handles invoicing, expenses, receipts, and profit & loss so your CPA has what they need at filing time. $149.95 lifetime or $5.95/month.
Get organized →This article is general educational information, not tax, legal, or accounting advice. Tax rates, limits, and thresholds change every year and sometimes mid-year — verify all current figures at IRS.gov and consult a licensed CPA or enrolled agent for your specific situation.
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