LLC vs Sole Proprietorship Taxes: Real Savings Math (2026)
Does Forming an LLC Alone Lower Your Taxes?
No — a default single-member LLC changes your federal tax bill by exactly $0. The IRS treats it as a disregarded entity, so you file the same Schedule C with your Form 1040 and pay the same 15.3% self-employment tax a sole proprietor pays. The savings people talk about only appear when you add an S-corp election, and in our worked example below that election is worth roughly $3,600 a year at $100,000 of net profit.
What a default LLC does change is legal, not tax-related: personal liability protection, a separate business identity for banking, and state paperwork. Formation filings generally cost $35 to $500 depending on the state, most states require an annual report, and California adds an $800 annual franchise tax. Those are costs, not savings.
If you have seen Reddit threads insisting an LLC does not save taxes, they are correct as far as they go — but many stop there and skip the point where the math flips. By default, an LLC is a legal shield, not a tax strategy; the tax savings live in the S-corp election, not in the LLC itself.
How Do Sole Prop, LLC, and S-Corp Taxes Actually Compare?
All three setups pay income tax at your individual rates by default — the real difference is how the 15.3% Social Security and Medicare tax applies. Here is the side-by-side, including what each route realistically costs to run.
| Item | Sole proprietorship | Single-member LLC (default) | LLC with S-corp election |
|---|---|---|---|
| Federal filing | Schedule C + Form 1040 | Schedule C + Form 1040 (disregarded entity) | Form 1120-S + W-2 salary + Form 1040 |
| 15.3% SE/payroll tax | On 92.35% of net profit | Identical to sole prop | Only on your W-2 salary; distributions exempt |
| 20% QBI deduction | Yes | Yes | Yes, on business income (not your own salary) |
| Typical yearly admin | $0 formation; licenses/DBA only | $35–$500 formation + annual report ($800/yr franchise tax in CA) | LLC costs + payroll service ~$500–$600 + S-corp return prep |
| Est. net savings at $100k profit | Baseline ($14,130 SE tax) | $0 vs. baseline | ≈ $3,600/yr after overhead |
One myth worth killing: the Section 199A qualified business income deduction of up to 20% is not an LLC perk — sole proprietors get it too, as of 2026. Every structure in this table is a pass-through by default, so the only line that moves real money is the self-employment tax line.
Where Is the S-Corp Break-Even Point?
Roughly $60,000–$80,000 of net profit — below that, the overhead of running payroll and filing a separate return usually eats the savings. Here is the full calculation at $100,000 so you can rerun it with your own numbers.
- As a sole proprietor, your SE tax base is 92.35% of $100,000 = $92,350.
- SE tax = $92,350 × 15.3% = $14,130 (half of it is deductible on your 1040).
- As an S-corp paying yourself a $60,000 reasonable salary, payroll tax = $60,000 × 15.3% = $9,180. The remaining $40,000 taken as distributions escapes the 15.3% entirely.
- Gross saving = $14,130 − $9,180 = $4,950.
- Subtract real overhead: ~$550 payroll service + ~$800 extra tax prep for the 1120-S (conservative assumptions) = $1,350. Net saving ≈ $3,600 — and in California, the $800 franchise tax cuts it to roughly $2,800.
| Net profit | Sole prop SE tax | S-corp payroll tax (assumed salary) | Gross saving | Est. net saving |
|---|---|---|---|---|
| $60,000 | $8,478 | $6,120 ($40k salary) | $2,358 | ≈ $1,000 |
| $100,000 | $14,130 | $9,180 ($60k salary) | $4,950 | ≈ $3,600 |
| $150,000 | $21,194 | $13,770 ($90k salary) | $7,424 | ≈ $6,100 |
Net savings assume the same $1,350 overhead and salaries that would plausibly pass the IRS reasonable-compensation test — a lower salary saves more but raises audit risk. Always judge the election on net savings — gross payroll-tax savings minus payroll service, extra tax prep, and state fees — never on the headline number. Note the 12.4% Social Security portion stops at the annual wage base; check ssa.gov for the current figure if your salary is high.
π Check it now on IRS — Internal Revenue ServiceHow Should You Choose? A 6-Point Checklist
Run your situation through this list before paying any formation fee. If most answers point to simplicity, staying a sole proprietor is a legitimate choice, not a failure to optimize.
- Net profit: consistently above ~$80,000, or still ramping?
- Liability exposure: do clients, premises, or products create real lawsuit risk?
- Your state's costs: a $50 filing in one state vs. $800 every year in California changes the math.
- Payroll tolerance: are you willing to run W-2 payroll for yourself, every month, forever?
- Growth plans: adding partners or investors later favors an LLC now (multi-member LLCs file Form 1065 with Schedule K-1s).
- Admin discipline: annual reports, separate bank accounts, and bookkeeping are non-negotiable once you form an entity.
Think of it as container and switch: the LLC is the container you form when liability demands it, and the S-corp election is the tax switch you flip only after profit clears break-even. Staying a sole proprietor makes sense while you are testing an idea, earning under the threshold, or doing low-liability work.
You do not have to decide everything at once. Form the LLC when you need the liability protection, keep default taxation, and file Form 2553 later — within 2 months and 15 days of the start of the tax year you want S-corp status to begin — once your profit reliably clears ~$80,000. You capture the savings exactly when they turn positive.
What Mistakes Cost Real Money?
Most losses here come from acting on forum advice without checking the numbers. One of the most expensive patterns is electing S-corp status too early: at $40,000–$50,000 of profit, $1,350+ of annual overhead can wipe out the entire payroll-tax saving.
- Forming in Delaware or Wyoming while operating elsewhere — you must register as a foreign LLC in your home state and pay two sets of fees and reports.
- Setting an unreasonably low S-corp salary to maximize distributions — the IRS can reclassify distributions as wages, with back payroll taxes and penalties.
- Assuming an LLC unlocks new deductions — a home office, mileage, and equipment are equally deductible on Schedule C either way.
- Forgetting state-level charges like franchise taxes and annual report fees when computing savings.
Forming an LLC never changes your tax deadlines. Quarterly estimated payments are still due either way because no tax is withheld from business income, and states like California bill the $800 franchise tax even in a $0-profit year. Missing these because you assume the new LLC handles it is a common — and avoidable — penalty trigger.
This article is general information, not tax or legal advice. Thresholds and dollar amounts change from year to year — verify current figures at irs.gov and run your own numbers with a CPA before making an election.
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FAQ
Does a single-member LLC pay more taxes than a sole proprietorship?
No. A default single-member LLC is a disregarded entity: identical Schedule C, identical 15.3% self-employment tax, identical income tax rates. Only state fees (like California's $800 franchise tax) make it cost more to operate.
At what income does an S-corp election make sense?
Commonly around $60,000–$80,000 of consistent net profit. Below that, payroll service and extra tax-prep costs (roughly $1,350+/yr) typically consume the payroll-tax savings. Rerun the break-even with your own state's fees before electing.
Can I deduct more business expenses with an LLC?
No. Ordinary and necessary business expenses — home office, mileage, equipment, software — are deductible on Schedule C whether you are a sole proprietor or a default LLC. The entity type does not expand your deduction list.
Do LLCs get the 20% QBI deduction too?
Both sole proprietors and LLC owners can claim the Section 199A deduction of up to 20% as pass-through businesses (as of 2026, subject to change). Under an S-corp, your own W-2 salary is excluded from QBI, which can slightly shrink the deduction.
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