Entity versus tax status
Two separate decisions hide inside this question.
- The legal entity is what you form with a state: a limited liability company or a corporation. It governs liability protection, ownership records and internal rules.
- The federal tax treatment is how the IRS taxes the profit. A corporation is taxed as a C corporation unless it elects S status. An LLC is taxed as a sole proprietorship or partnership by default, and can elect to be taxed as a C corporation or an S corporation.
So "LLC or S corp" is often a false choice. See pass-through taxation explained. Many small businesses are LLCs that have elected S corporation tax treatment.
Side by side
| LLC (default tax) | S corporation | C corporation | |
|---|---|---|---|
| How profit is taxed | Passes through to owners and is taxed on their returns | Passes through to shareholders and is taxed on their returns | Taxed at the company level at 21%, then again when paid out as dividends |
| Self-employment tax on owners' share | Generally yes, for owners who work in the business | Only on the salary paid to owners, not on distributions | Only on salary paid to owners |
| Who can own it | Anyone, including foreign persons and companies | Up to 100 shareholders, generally US citizens or residents, no partnerships or corporations | Anyone |
| Classes of ownership | Flexible, profit splits can differ from ownership | One class of stock only | Multiple classes allowed |
| Owner salary required | No | Yes, a reasonable salary for owners who work in it | If owners work in it and take pay, it is salary |
| Paperwork | Lightest | Payroll plus a corporate return every year | Corporate formalities plus a corporate return every year |
| Raising outside investment | Possible but less standard | Limited by the ownership rules | The usual choice for investor-backed startups |
When a plain LLC fits
An LLC taxed under the default rules suits a business that is small, profitable enough to cover the owner's living costs, and run by people who want the least paperwork. Profit is reported once, on the owners' returns. The owners pay income tax and, if they work in the business, self-employment tax on their share. For 2026 that self-employment tax is 15.3% on net earnings up to the $184,500 Social Security wage base, and 2.9% above it.
It is also the natural starting point for owners who are not US persons, because the S corporation route is closed to them.
When S corporation status fits
The S election changes how owners who work in the business are paid. Instead of paying self-employment tax on all of their share of profit, they take a salary, which is subject to payroll taxes, and receive the rest as distributions, which are not. That is where the saving comes from.
The saving has limits and costs:
- The salary has to be reasonable for the work done. The IRS can reclassify distributions as wages when the salary is set artificially low.
- Running payroll, filing quarterly payroll returns and filing Form 1120-S each year all cost time and money.
- At lower profit levels, those costs can wipe out the payroll tax saving.
- The ownership rules are strict. A single ineligible shareholder, such as a nonresident alien or another corporation, ends the election.
The election is made on Form 2553. To take effect for a tax year, it generally has to be filed no more than 2 months and 15 days after that year begins, or at any time during the year before.
When a C corporation fits
A C corporation pays federal tax on its own profit at a flat 21%, on Form 1120. When it pays dividends, shareholders pay tax again on what they receive. That double layer is the classic drawback. The setup steps are in how to form a C corporation.
A C corporation still makes sense in several situations:
- You plan to raise money from investors. Venture investors generally expect a corporation, often one formed in Delaware, with preferred shares. See Delaware C corp for startups.
- You will keep most profit in the company to grow it. Profit that is not paid out is taxed only once, at 21%, until it is distributed.
- Owners include foreign persons, corporations or many shareholders in ways the S corporation rules do not allow.
The numbers are worked through in C corp double taxation.
If any owner is not a US person
A nonresident alien cannot be a shareholder of an S corporation. See can a non-resident own an S corp. That leaves two practical choices: an LLC, taxed under the default rules or as a corporation, or a C corporation. The tax consequences for a foreign owner turn on where the business activity takes place. See whether foreign-owned US LLCs pay US tax.
Switching later
You can usually start as an LLC and change the tax treatment later without forming a new company. An LLC can elect S status once the numbers justify it, or elect to be taxed as a corporation. Moving the other way, from a corporation back to pass-through treatment, can trigger tax, so it pays to think one or two years ahead before electing corporate status.
A quick way to decide
- New business, modest profit, US owners: start as an LLC under the default rules.
- Very small or occasional income: compare LLC vs sole proprietorship first.
- Established business with steady profit and owners on the payroll: compare the payroll tax saving of S status against its extra costs.
- Raising outside capital or reinvesting most profit: look at a C corporation.
- Any owner is not a US person: LLC or C corporation, not S.
Not sure which structure fits?
Tell us how the business earns money, who owns it and what you plan to do with the profit. We will set out the tax result under each option before you file anything.
Questions people ask
Is an S corp a type of company I can register with the state?
No. The state registers a corporation or an LLC. S corporation status is a federal tax election made on IRS Form 2553.
Can an LLC be taxed as an S corporation?
Yes, if it meets the S corporation rules on shareholders and ownership. The LLC files Form 2553, and is then treated as a corporation that has elected S status.
Can a foreigner own an S corporation?
No. A nonresident alien cannot be an S corporation shareholder, and one ineligible shareholder ends the election. Foreign owners use an LLC or a C corporation instead.
What is the federal tax rate for a C corporation?
A flat 21% on taxable income. Dividends paid to shareholders are then taxed again on the shareholders' side.
When does an S corp election save money?
When the payroll tax saved on distributions is larger than the added cost of payroll and a separate return. That depends on profit level, a reasonable salary for the owner's role, and state taxes, so it needs working out with your own numbers.
Sources
Every fee, date and rule on this page was taken from these official and primary sources.
- Internal Revenue Code section 11: 21% corporate tax rate
- Internal Revenue Code section 1361: S corporation eligibility
- IRS: Instructions for Form 2553
- Social Security Administration: Contribution and benefit base, 2026
Rules and fees change. If you are reading this long after September 30, 2026, confirm the figures with the source before you rely on them.
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This guide is general information. It is not tax or legal advice for your situation.