Sole Prop vs LLC Taxes: Will You Pay More?
Most new founders think an LLC lowers their tax bill. It doesn’t. Here is the math on why they are legally different but fiscally identical—until you pull the “S-Corp” lever.
The Tax Identity Crisis
The IRS does not see your LLC. They look right through it to you. This is called being a “Pass-Through” entity.
| Structure | IRS Classification | Tax Form |
|---|---|---|
| Sole Prop | Self-Employed | Schedule C |
| Single LLC | Disregarded Entity* | Schedule C |
| LLC (S-Corp) | Corporation | Form 1120-S |
| C-Corp | Double Taxed | Form 1120 |
| Goal | Best Structure |
|---|---|
| Simplicity | Default LLC |
| Tax Savings | S-Corp LLC |
If Taxes Are the Same, Why Bother?
You don’t form an LLC for tax breaks; you form it for Sleep Insurance.
The “Corporate Veil”
- Sole Prop: If someone sues your business, they can take your personal house, car, and savings. You and the business are the same person.
- LLC: If someone sues the business, they can generally only take the assets inside the company. Your personal house is shielded (assuming you didn’t pierce the veil).
The Advanced Move: S-Corp Election
Once your business makes over $80,000 in net profit, the “Self-Employment Tax” (15.3%) becomes painful. This is when you file Form 2553.
How It Saves Money
An S-Corp splits your money into two buckets:
- Bucket A (Salary): Subject to 15.3% SE Tax. (Reasonable Salary).
- Bucket B (Distribution): NOT subject to 15.3% SE Tax. (Just Income Tax).
By taking part of your profit as a “Distribution,” you legally skip the payroll tax on that portion.
Pro Tip: The “Delaware” Trap
If you operate from California, you must register your Wyoming LLC as a “Foreign LLC” in California and pay California taxes anyway. You end up paying fees to BOTH states. Always form your LLC in the state where you actually work.