Here's the tax truth that surprises most new business owners: an LLC taxed as a sole proprietorship pays exactly the same federal taxes as a sole proprietorship. The LLC structure itself doesn't change your tax obligations—it's all about how the IRS classifies your business for tax purposes.
The real tax advantages come from two things:
Your personal assets are protected from business debts and lawsuits
Can reduce self-employment tax by 50% or more on profits above a reasonable salary
Here's how the three main options stack up for a business with $100,000 in annual profit:
Tax Aspect | Sole Proprietorship | LLC (Default Tax) | LLC (S‑Corp Election) |
|---|---|---|---|
| Federal Income Tax | Personal return (Schedule C) | Personal return (Schedule C) | Pass-through (K-1 distribution) |
| Self-Employment Tax (Social Security & Medicare) | 15.3% on full $100K profit $15,300 total | 15.3% on full $100K profit $15,300 total | 15.3% on $50K salary only $7,650 total (50% savings) |
| Payroll Requirements | None | None | Quarterly payroll taxes W-2 for yourself |
| Administrative Complexity | Very Low | Very Low | Medium (payroll setup required) |
| Total Tax Savings vs Sole Prop | $0 | $0 | $7,650 annually |
Self-employment tax is where most business owners get hit hardest. This 15.3% tax covers both the employee and employer portions of Social Security (12.4%) and Medicare (2.9%) taxes that traditional employees don't pay directly.
Provides retirement and disability benefits (up to $168,600 income in 2025)
Healthcare benefits (no income limit)
Applies to income over $200,000 (single) or $250,000 (married filing jointly)
The good news: You can deduct half of your self-employment tax as an adjustment to income on your personal tax return. For the $100,000 profit example above, you'd deduct $7,650, effectively reducing your taxable income.
The S-Corp election is a tax strategy where you become an employee of your own business. You pay yourself a "reasonable salary" and treat the remaining profits as distributions (which aren't subject to self-employment tax).
Or by March 15 of the following year for existing LLCs
Must be comparable to what you'd pay someone else for your role
Form 941 for federal taxes, plus state unemployment taxes
For the salary portion (distributions reported on Schedule K-1)
Scenario | Annual Profit | Self-Employment Tax | Annual Savings |
|---|---|---|---|
| Sole Proprietorship | $100,000 | $15,300 | $0 |
| S-Corp (50/50 split) | $100,000 | $7,650 | $7,650 |
| S-Corp (60/40 split) | $100,000 | $9,180 | $6,120 |
The S-Corp election typically makes financial sense when your business profit exceeds $50,000-$60,000 annually. Below that threshold, the administrative complexity and payroll setup costs often outweigh the tax savings.
While federal taxes are identical for sole proprietorships and LLCs taxed as sole proprietorships, state taxes can vary significantly. Here's what you need to know:
Most states follow the federal tax treatment—meaning LLCs taxed as sole proprietorships are treated the same as sole proprietorships for state income tax purposes. However, some states have their own rules:
LLCs pay an $800 annual LLC fee plus income-based fees, regardless of federal tax treatment
LLCs and corporations pay Texas franchise tax; sole proprietorships may be exempt
All business types benefit from Nevada's business-friendly tax environment
Both sole proprietorships and LLCs must collect and remit sales tax on taxable sales. The business structure doesn't affect sales tax obligations—it's based on what you sell and where you sell it.
Both sole proprietorships and LLCs (taxed as sole proprietorships) must make quarterly estimated tax payments if they expect to owe $1,000 or more in taxes for the year. This includes:
Based on your expected annual income and deductions
15.3% of net profit (after the 50% deduction)
Varies by state; use state worksheets to calculate
Good record keeping is crucial for both business structures. The IRS requires you to keep records that support your income, expenses, and deductions for at least 3 years (6 years if you underreport income by more than 25%).
If you work from home, deduct a portion of rent/mortgage, utilities, and internet
Mileage (67¢ per mile in 2025) or actual expenses
Computers, software, office supplies, and business-related purchases
Website costs, business cards, online ads, and promotional expenses
Legal fees, accounting fees, and business formation costs
Legal fees, filing fees, and organizational expenses (can amortize over 15 years)
Annual registered agent service fees are deductible
Legal fees for drafting your operating agreement
The choice between sole proprietorship and LLC depends on your specific business situation, risk tolerance, and growth plans. Here's a decision framework:
• You're just testing a business idea and want maximum simplicity
• Your business has minimal liability risk (consulting, freelance work)
• You want to avoid any additional paperwork or fees
• Your personal assets are already protected through other means
• You don't anticipate significant business growth in the near term
• You want personal liability protection for your business activities
• You might want to elect S-Corp status later for tax savings
• Your business involves any physical products or services with liability risk
• You want to project a more professional image to clients and vendors
• You're planning for business growth and want flexibility in ownership structure
Form your business (LLC, S-Corp, or C-Corp) completely free - pay only state filing fees with no service charges. Add professional registered agent service ($99/year) for compliance reminders, privacy protection, and expert support.
Detailed comparison of all business entity types and their tax implications.
Learn about operating agreement requirements and get professional help with drafting.