Comparing Business Entities for Taxes – Which One Maximizes Your Tax Savings?

Choosing the right business type is one of the most important decisions you’ll make for your business.
It affects how your business is run, how much legal protection you get, and how much you pay in taxes each year. 

Each type of business structure—Sole Proprietorship, LLC, Partnership, S-Corp, and C-Corp—has different tax implications. 

And each business structure type has situations where it should be the one leveraged for your business.
It’s important to understand how each one works and which one will help you save the most money.

In this article, we’ll compare the tax details of each type of business, look at the factors that can influence your decision, and help you decide which structure is best for your business. 

By considering liability protection, self-employment taxes, benefits, and the ability to raise money, you can make a smart decision that helps you save more.

Please note: Make Taxes Fair is not a legal firm and this article is general in nature and scope and should not be relied upon to finalize your decision regarding your entity selection. We advise that you consult an attorney and a qualified tax professional to ensure that your entity selection is optimal for you.

Key Factors to Consider When Choosing an Entity

Before we compare different types of businesses, it’s important to understand the key factors that should influence your choice.
 
These include liability protection, self-employment taxes, corporate taxes, benefits, and access to capital. 
Picking the right business type based on these goals can help you save on taxes and protect your business.

1. Liability Protection

How much personal protection do you need from the business’s debts and risks? 

For example, a Sole Proprietorship offers no liability protection, which means you are personally responsible for any debts or lawsuits against the business. 

LLCs, S-Corps, and C-Corps, however, can protect your personal assets if the business runs into financial trouble or legal issues.

LLCs give their owners (or members) limited liability protection, which means they usually aren’t personally responsible for business debts. 

S-Corps and C-Corps offer similar protection to shareholders, making them a good option if you want to protect your personal assets.

2. Self-Employment Taxes

With some business types, like Sole Proprietorships, Partnerships, and default LLCs, you have to pay self-employment taxes on all your profits. 

Self-employment taxes go toward Social Security and Medicare, and they add up to 15.3% of your net earnings. 

This can result in a large tax bill, especially if your business is doing well.

S-Corps are different because you can pay yourself a salary and take the rest as distributions, which means you might pay less in self-employment taxes. 

This can save you thousands of dollars each year, but you have to make sure you’re following IRS rules about paying yourself a fair or “reasonable” salary.

3. Corporate Taxes

C-Corporations are taxed twice—once at the business level and again when profits are paid to shareholders as dividends. 

The company pays taxes on its profits, and then shareholders pay taxes on the money they receive. 
The corporate tax rate is 21% (as of 2024), which might be lower than the individual tax rate if you’re making a lot of money.

S-Corps and LLCs avoid this by being pass-through entities. 

In a pass-through entity, the business itself doesn’t pay income tax. 

Instead, profits go straight to the owners, who report them on their personal tax returns. 
This helps avoid the issue of double taxation and can save smaller businesses a lot of money.

4. Fringe Benefits

C-Corporations can offer many types of tax-deductible benefits like health insurance, retirement plans, and education assistance. 

These benefits are not taxable for employees, which makes C-Corps a great choice for business owners who want to offer substantial benefits to themselves and their employees.

S-Corps and LLCs can also offer some benefits, but there are limits on what can be deducted and how they are taxed. 

Understanding these differences can help you pick the best business type, especially if keeping employees happy is a priority.

5. Ease of Raising Capitals

If you want to grow your business and raise money from investors, C-Corporations have significant advantages because they can issue stock and have unlimited shareholders. 

This makes C-Corps the best type of business if you want to get venture capital or eventually go public.

S-Corps are limited to 100 shareholders, and only certain types of investors can be shareholders. 

They also can’t have foreign shareholders and can only issue one class of stock, which might make them less appealing to some investors. 

LLCs also have some limits on raising money, but they are more flexible than S-Corps in terms of ownership and how profits are shared.

Entity Comparison Chart

The following chart gives a simple comparison of the leading tax implications and benefits for each type of business:

When to Choose Each Entity

Choosing the right business type depends on the size of your business, how much you want to grow, your profit, and your risk. Here’s a closer look at when each type makes sense.

1. Sole Proprietorship

Best For: Freelancers, consultants, and small businesses with low profits and minimal risk.
Why: It’s easy to set up, and there aren’t any special rules you have to follow. 

Sole Proprietorships are great for small businesses with little legal risk, like freelancing or consulting. 

However, you are personally responsible for all debts and liabilities, and you have to pay self-employment taxes on all your profits, which can add up as your business grows.

2. LLC (Single or Multi-Member)

Best For: Small to medium-sized businesses that need liability protection and flexible taxes.
Why: LLCs give you liability protection, and profits are only taxed on your personal return. 

You can also choose to have your LLC taxed as an S-Corp or C-Corp, which gives you even more flexibility. 

LLCs are good for businesses that want some protection from liability but don’t need the full complexity of a corporation. 

They also make it easy to manage the business and share profits among members.

LLC’s are optimal for “passive” income investments such as rental properties.

3. S-Corporation

Best For: Businesses with significant profits that want to lower self-employment taxes.
Why: S-Corps let you pay yourself a salary (which has payroll taxes) and take the rest of the profits as distributions, which don’t have self-employment taxes. 

This setup can lower your tax bill, but there are more rules, like having to file Form 1120-S and making sure you pay yourself a fair salary. 

S-Corps are great for businesses that are making steady profits and want to reduce tax costs.

S-Corps are optimal for “active” income activities such as running a business. Passive income activities such as rental properties should not be held in an S-Corp in the very vast majority of situations.

4. C-Corporation

Best For: Businesses that want to grow quickly, raise money, or offer lots of employee benefits.
Why: C-Corps can offer tax-deductible benefits and keep profits in the company for future growth. 

They can also issue different types of stock, which makes them attractive to investors and venture capitalists. 

Although they are taxed twice, the benefits can make up for it if your business is growing fast or needs outside investors. 

C-Corps are also the right choice if you plan to go public one day.

When to Consider Switching Entities

As your business changes, the type of entity you first chose might not be the best anymore. Here are some signs that it might be time to switch:

• You’ve outgrown your Sole Proprietorship: As your profits grow or your risks increase, moving to an LLC or S-Corp can give you liability protection and help you save on taxes. Switching to an LLC protects your personal assets, and an S-Corp election can help you pay less in self-employment taxes.
• You’re paying too much in self-employment taxes: If you’re a Sole Proprietor or an LLC and making enough money, changing to an S-Corp might help you save money. It lets you take part of your profits as distributions, which aren’t subject to self-employment taxes.
• You need to raise capital: If your business is growing and you need investors, changing to a C-Corporation might make it easier. C-Corps are more attractive to investors because they can offer different types of stock and have no limits on shareholders.

Final Thoughts

Choosing the right type of business structure is very important for saving money on taxes, protecting your assets, and helping your business grow. 

While no one structure is perfect for every business, understanding the tax implications and benefits of each can help you make the best choice. 

As your business grows, it’s smart to think about changing your business type to save money, meet your growth goals, and protect your financial future.

If you’re still not sure which business type is right for you, consider talking to a tax professional who can give you personalized advice. 

Getting the right help can save you money, reduce your risk, and ensure your business structure supports your long-term goals.

In the next article, we’ll discuss when and how to switch business types to get the most tax savings as your company grows.  We will cover the steps you need to take, the forms you’ll need, and how making the switch at the right time can benefit you. Have questions or need help? Reach out and start a conversation today.