1. The biggest myth about LLC taxes
This is one of the most widespread misconceptions among new business owners — and it is simply not true by default.
Here is the reality the IRS is very clear about: an LLC is a legal structure, not a tax identity. The IRS does not have a separate tax category called "LLC." When you form a single-member LLC, the IRS treats it as a "disregarded entity" — meaning for federal income tax purposes, it does not exist separately from you.
The result: a single-member LLC and a sole proprietorship file the exact same tax forms and pay the exact same self-employment tax rate. There is zero tax difference at the default level.
LLC = a legal identity (protects personal assets)
Sole proprietorship = also a legal structure, but with no separation
Neither one is a tax identity by itself. Tax treatment is a separate election.
2. How sole proprietorship taxes work
A sole proprietorship is the simplest business structure. You and your business are legally the same person. For taxes:
- All business income and expenses go on Schedule C, attached to Form 1040
- Net profit is subject to self-employment tax of 15.3% (12.4% Social Security + 2.9% Medicare)
- You then pay federal income tax on top, at your personal bracket rate
- You can deduct half of SE tax (7.65%) from gross income before calculating income tax
No separate business tax return. No payroll. Straightforward — but SE tax on every dollar of profit adds up fast.
3. How LLC taxes work — by default
A single-member LLC's default IRS classification is "disregarded entity." This means:
| Structure | Tax form | SE tax on profits | Legal protection |
|---|---|---|---|
| Sole proprietorship | Schedule C + 1040 | 15.3% on all net profit | None |
| Single-member LLC (default) | Schedule C + 1040 | 15.3% on all net profit | Yes |
| Multi-member LLC (default) | Form 1065 + K-1 | 15.3% on each member's share | Yes |
Source: IRS Single Member LLC guidance; IRS Publication 3402
4. The S corp election — the only way an LLC saves tax
An LLC can elect to be taxed as an S corporation by filing Form 2553. This is the only mechanism through which an LLC can actually reduce your self-employment tax — and it only works above a certain income threshold.
How it works
With an S corp election, the IRS requires you to split your income into two parts:
- Reasonable W-2 salary — subject to payroll taxes (employer + employee share = 15.3%)
- Distributions — remaining profit passed through to you, not subject to self-employment tax
As sole proprietor: SE tax on full $120,000 = ~$16,955
With S corp election: Pay yourself $70,000 salary (SE tax = ~$9,889) + $50,000 distribution (no SE tax)
Estimated saving: ~$7,066/year — minus payroll admin costs of ~$1,500–$3,000/year
1. The IRS requires a reasonable salary — you cannot pay yourself $1 to avoid all payroll taxes. The IRS actively audits this.
2. You must set up formal payroll, file quarterly payroll tax returns, and issue yourself a W-2. This adds administrative complexity and cost.
3. Most tax professionals only recommend this when net profit consistently exceeds $60,000–$80,000/year. Below that, the admin costs usually outweigh the savings.
5. Calculator: which structure fits your income?
Enter your estimated annual net profit to see which structure makes sense and estimate your potential S corp savings.
6. Full side-by-side comparison
| Factor | Sole proprietorship | Single-member LLC |
|---|---|---|
| Setup cost | $0 | $35–$800+ (state filing fee) |
| Annual maintenance | None | $0–$500+ depending on state |
| Federal tax forms | Schedule C + 1040 | Same by default |
| Self-employment tax | 15.3% on all profit | 15.3% on all profit (default) |
| Tax identity | Pass-through (personal return) | Pass-through (personal return, same) |
| Personal liability protection | None | Yes — if properly maintained |
| S corp election available | No | Yes (Form 2553) |
| Business bank account required | No (recommended) | Strongly recommended to preserve liability protection |
| Credibility with clients | Standard | Slightly higher perception |
| Easier business financing | Depends on income/credit | May help perception, but lenders primarily look at income, credit score, and cash flow — not entity type |
- Net profit is under $50,000/year
- You want zero setup cost and paperwork
- Your business has minimal liability risk
- You're testing a business idea
- You have real liability exposure
- You want to eventually elect S corp status
- Net profit is above $60,000 and growing
- You work with clients who expect a formal business entity
7. California LLC — a real cost warning
If you are in California, LLC costs are significantly higher than most states and are often underreported online.
| California LLC cost | Amount | Notes |
|---|---|---|
| State formation fee | $70 | One-time |
| Minimum annual franchise tax | $800 | Due every year, regardless of profit or loss |
| Gross receipts fee (if applicable) | $900–$11,790+ | Applies if gross receipts exceed $250,000 |
Source: California Franchise Tax Board, 2025
Not sure which structure is right for you?
Every business situation is different. If you have international income, multiple clients, or are considering an S corp election, it helps to talk through your specific numbers.