LLC vs. Sole Proprietorship vs. S-Corp: Which Is Right?

The Quick Answer: What's the Difference?

A sole proprietorship is the default status the moment you start doing business under your own name, with no separate legal entity and no liability protection. An LLC (limited liability company) is a formal business entity, registered with your state, that separates your personal assets from your business's debts and legal liabilities. An S-corp isn't a business structure at all, it's a tax election: either an LLC or a corporation can choose to be taxed as an S-corp once it meets certain requirements, which can reduce self-employment tax for profitable businesses.

Sole Proprietorship: The Default Option

How It's Taxed

All business profit passes through to your personal tax return on Schedule C. You pay ordinary income tax plus self-employment tax, 15.3% for Social Security and Medicare, on the entire net profit.

Liability Risk

This is the biggest downside: there's no legal separation between you and the business. If it's sued or can't pay a debt, your personal assets, car, savings, even your home, are on the line.

Best For

Testing a new business idea, low-risk side income, or freelance work with minimal liability exposure, where the cost and paperwork of forming an LLC isn't yet worth it.

LLC: Limited Liability Company

How It's Taxed by Default

A single-member LLC is, by default, a "disregarded entity" for tax purposes, the IRS taxes it exactly like a sole proprietorship, with profit reported on your personal return and the same 15.3% self-employment tax applying to net income. Forming an LLC changes your legal liability, not your tax treatment, a detail that surprises many new owners. Tax savings only show up if you additionally elect S-corp status once profit justifies it.

Liability Protection

This is the LLC's main advantage: it creates a legal separation between your personal assets and business debts or lawsuits, as long as you maintain that separation (a business bank account, proper contracts, and not commingling funds).

Paperwork and Costs

Forming an LLC requires filing Articles of Organization with your state and paying a filing fee, which varies by state, plus possible ongoing annual report fees or franchise taxes depending on where you're registered.

Best For

Businesses with any real liability exposure, client-facing services, physical products, contracts, where personal asset protection is worth the modest setup cost and paperwork.

S-Corp: A Tax Election, Not a Business Structure

How S-Corp Taxation Works

When an LLC elects S-corp tax status with the IRS, the owner becomes an employee of the business, paying themselves a "reasonable" salary through payroll, with any remaining profit taken as a distribution instead of salary.

The Self-Employment Tax Savings

This is the entire appeal: only your salary is subject to the 15.3% self-employment (payroll) tax. Profit distributed above salary isn't, which is where the real savings come from for a profitable business.

When the Election Makes Sense

As a general benchmark, once net profit is consistently above roughly $80,000 a year, the tax savings from an S-corp election, often estimated in the $5,000–$15,000 range annually, tend to outweigh the added costs. Below that threshold, the extra compliance work usually isn't worth it.

The Trade-Offs

S-corp status requires running actual payroll (with processing costs), filing a separate business tax return, and paying a defensible "reasonable" salary, the IRS scrutinizes owners who pay themselves an artificially low salary to dodge payroll taxes. It's more administrative work than a plain LLC, which is why it only pays off once profit is high enough.

A Worked Example

Imagine a consultant whose LLC nets $120,000 in profit for the year. Taxed as a default LLC, the entire $120,000 is subject to the 15.3% self-employment tax, roughly $18,360. With an S-corp election, the owner might pay themselves a reasonable salary of $65,000 (subject to payroll tax) and take the remaining $55,000 as a distribution not subject to self-employment tax. That shifts the tax base down to $65,000, around $9,945, a rough savings of $8,400 before the added cost of payroll processing and a separate tax return, which might run $1,500–$3,000 a year. The net savings is still meaningfully positive, which is why the election tends to make sense above roughly $80,000 in profit.

A Note on Multi-Member LLCs and Partnerships

Everything above focuses on single-owner businesses, but the same logic extends to multi-member LLCs. By default, an LLC with more than one owner is taxed as a partnership: profit passes through to each member's personal return based on ownership share, and each pays self-employment tax on their portion. A multi-member LLC can also elect S-corp taxation once profitable enough, with each owner-employee drawing a reasonable salary. Liability protection works the same as a single-member LLC, shielding each owner's personal assets from the business's debts.

Side-by-Side Comparison

Liability protection: Sole proprietorship, none. LLC, yes. S-corp election, yes (inherits the underlying LLC or corporation's protection)

Default tax treatment: Sole proprietorship, personal return, full self-employment tax. LLC, same as sole proprietorship by default. S-corp, salary + distributions, partial self-employment tax savings

Paperwork: Sole proprietorship, minimal. LLC, state filing plus annual maintenance. S-corp, LLC filing plus payroll and a separate business tax return

Typical cost: Sole proprietorship, little to none. LLC, state filing fee, often $50–$500 depending on the state. S-corp, LLC costs plus payroll service and added accounting fees

Best fit: Sole proprietorship, testing an idea, minimal risk. LLC, real liability exposure, moderate profit. S-corp, consistently profitable business, generally above ~$80,000 in net profit

How to Decide Which Structure Is Right for You

A simple way to think through it:

Just testing an idea with little liability exposure? A sole proprietorship is a reasonable place to start.

Have any real liability risk, clients, contracts, physical products, employees? Form an LLC.

Is your LLC consistently profitable, well above $80,000 in net profit? Ask an accountant whether an S-corp election makes sense for your specific numbers.

Because the right choice depends on your state, industry, and actual numbers, this is a good moment to bring in a CPA or business attorney, the cost of that conversation is small compared to untangling the wrong structure later.

State-Specific Considerations

Everything above describes federal tax treatment, but LLC formation and ongoing fees are set at the state level and vary widely. Some states charge a low, one-time filing fee with no annual requirement; others impose an annual franchise tax or minimum fee whether or not the business turns a profit. Before forming an LLC, check your state's Secretary of State website for current filing fees, annual report requirements, and any franchise or minimum business tax, these ongoing costs factor into whether an LLC, or later an S-corp election, is worth it where you operate.

It's also worth checking whether your state recognizes the S-corp election for state income tax purposes the same way the IRS does, most do, but a few tax S-corps differently or impose their own entity-level tax, which changes the math on whether the election is worthwhile.

Frequently Asked Questions