Business Entity Taxes — LLC, S-Corp, C-Corp, and Pass-Through Taxation

Why Entity Choice Matters

The legal structure of your business determines how its income is taxed, which forms you file, and what deductions are available. The choice between a sole proprietorship, LLC, S-Corp, and C-Corp can mean tens of thousands of dollars per year in tax differences.

Sole Proprietorship / Single-Member LLC (Disregarded Entity)

The default for solo business owners. All income and expenses flow directly to Schedule C of Form 1040.

Self-Employment Tax (SE Tax)

15.3% on net self-employment income up to $168,600 (2024) (12.4% Social Security + 2.9% Medicare) 2.9% Medicare tax on income above$ 168,600
Additional 0.9% Medicare surcharge above $200,000 (single) /$ 250,000 (MFJ)

Above-the-line deduction

You can deduct the employer-equivalent half (7.65%) of SE tax from gross income
This reduces AGI — available whether or not you itemize

\begin{aligned} &\text{Example}: \$100,000 \text{net Schedule} C \text{income} \\ \text{SE tax}: \$100,000 \times 92.35\% \times 15.3\% &= \$14,130 (approx.) \\ \text{Income tax on}: \$100,000 − \$7,065 (\text{deduction}) &= \$92,935 \text{of ordinary income} \end{aligned}

Partnership and Multi-Member LLC

Two or more owners. Files Form 1065 (information return); each partner receives a Schedule K-1 showing their share of income, deductions, and credits.

Key features:

Pass-through: income taxed to partners at their individual rates
Flexibility in profit/loss allocation (subject to economic substance rules)
Partners who are active in the business pay SE tax on their distributive share

S-Corporation

An S-Corp is a pass-through entity that can reduce self-employment taxes by splitting income between a “reasonable salary” (subject to FICA) and distributions (not subject to SE tax).

Structure — S-Corp net income = Salary (FICA-taxed) + Distribution (no SE tax)

Example: $200,000 net profit
- Sole proprietor: SE tax on ~ $200,000 = ~$ $200, 000 =$ 28,000 SE tax S-Corp (salary $100,000, distribution$ $100, 000, d i s t r ib u t i o n$ 100,000):
  - SE tax on salary: $100,000 × 15.3% =$ 15,300
  - SE tax on distribution: $0
  - SE tax saving: ~$12,700
Requirement: must pay yourself a “reasonable compensation”
IRS scrutinizes excessively low salaries to avoid payroll tax

S-Corp Eligibility Requirements

✓ Domestic corporation
✓ No more than 100 shareholders
✓ All shareholders are US citizens or residents
✓ Only one class of stock
✓ Cannot be a bank, insurance company, or certain other entities

C-Corporation

C-Corps are separate taxpaying entities — income is taxed at the corporate level, then again when distributed as dividends (double taxation).

Corporate Tax Rate: flat 21% (Tax Cuts and Jobs Act, 2017)

Double Taxation

Corporate profit: $1,000,000
Corporate tax (21%): $210,000
After-tax profit: $790,000
Dividend paid: $790,000
Shareholder tax (qualified dividend, 15%): $118,500
Total tax: $328,500 (effective ~32.9%)

vs. S-Corp or LLC

$1,000,000 × ~37% top individual rate =$ 370,000 (worst case)
But lower rate owners may pay less via pass-through

When C-Corp Makes Sense

✓ Seeking venture capital (VCs prefer C-Corps; S-Corp restrictions apply)
✓ Planning for IPO
✓ Expecting long reinvestment phase (retain earnings at 21% vs. 37% pass-through)
✓ Qualified Small Business Stock (QSBS) exclusion: up to 100% capital gains exclusion on C-Corp stock held >5 years (up to $10 million gain)

The 20% QBI Deduction (Section 199A)

Pass-through business owners (sole props, partnerships, S-Corps) may deduct up to 20% of qualified business income (QBI) from taxable income.

Basic calculation — QBI Deduction = 20% × QBI (subject to limitations)

Limitations phase in for higher-income taxpayers

Single: phaseout begins at $191,950 (2024)
MFJ: phaseout begins at $383,900

Specified Service Trades or Businesses (SSTBs)

Law, accounting, consulting, financial services, etc.

QBI deduction phases out completely above income thresholds

Non-SSTB businesses

At high income, deduction limited to the greater of:
(a) 50% of W-2 wages paid, or
(b) 25% of W-2 wages + 2.5% of unadjusted basis of qualified property

\begin{aligned} \text{Example}: \text{Single}, \text{taxable income} \$150,000, QBI &= \$80,000 (\text{non-SSTB}) \\ \text{QBI deduction}: \$80,000 \times 20\% &= \$16,000 \\ &(\text{under phaseout threshold}, \frac{\text{no wage}}{\text{property limitation applies}}) \\ \text{Taxable income after deduction}: \$150,000 − \$16,000 &= \$134,000 \end{aligned}

Retirement Plans for Business Owners

Business owners have access to higher-limit retirement plans than employees.

SEP-IRA

Contribution: up to 25% of net self-employment income
2024 limit: $69,000 Simple to set up; no annual filing required

Solo 401(k) (Individual 401(k))

Employee contribution: $23,000 ($ 30,500 age 50+)
Employer contribution: up to 25% of compensation
2024 combined limit: $69,000 ($ 76,500 age 50+) Can invest in almost anything; Roth option available

SIMPLE IRA

For businesses with ≤100 employees

2024 limit: $16,000 ($ 19,500 age 50+) Employer must match up to 3% or contribute 2% flat

Entity Selection Summary

Entity	Tax Treatment	SE Tax	Complexity	Best For
Sole Prop / SMLLC	Schedule C (pass-through)	Full SE tax	Low	Solo, low income
Multi-member LLC	Form 1065 (pass-through)	Active partners pay SE	Low-Medium	Small partnerships
S-Corp	Pass-through, K-1	Salary only	Medium	>~$80K net profit
C-Corp	Double taxation (21%)	No SE	High	VC-backed, IPO, QSBS

Practice Quiz

Q1. You are a self-employed consultant earning $120,000 net. What is your approximate SE tax?

Net SE income = $120,000 × 92.35% = $110,820.
SE tax = $110,820 × 15.3% ≈ $16,955.

Q2. Why would a business owner elect S-Corp status rather than staying a sole proprietor?

To reduce SE taxes by paying a reasonable salary subject to FICA/Medicare and taking remaining profits as distributions (not subject to SE tax). This strategy becomes meaningful roughly when net profits consistently exceed $80,000–$100,000.

Q3. A married couple earns $150,000 QBI from an S-Corp (non-SSTB). What is their QBI deduction?

QBI deduction = $150,000 × 20% = $30,000 (well below the MFJ $383,900 phaseout threshold; no wage limitation applies at this level).