What’s the Most Tax-Efficient Business Structure? A Comprehensive Guide

Did you know that significant tax savings begin with the foundation of your business?

Business structure is often taken for granted. It may be assumed that you should form a C-Corp or an LLC, and leave it at that. Few recognize that this is a strategic decision with substantial tax implications, and not just a formality.

Depending on the size of your business, annual revenue, and number of partners and employees, you could be drastically overpaying on your personal income and business income taxes each year. Your business structure will also have a substantial impact on your exit; the wrong business structure could result in a massive tax bill at the time of sale. 

This guide examines the most common business structures and their tax implications to help you choose the right one for your company.

Key Takeaways

• The primary business structures you will encounter are a sole proprietorship, a partnership, an LLC, and a corporation (specifically, C-Corp and S-Corp). 
• C-Corps and LLCs that elect to be taxed as a C-Corp are “double-taxed,” meaning the business pays tax on its profits and then owners pay personal tax on dividends.
• For that reason, an S-Corp (or an LLC taxed as an S-Corp) is frequently considered to be the optimal business structure, offering the upside of a corporation without the disadvantages of double taxation.
• You can change your business structure as your team size, revenue, exit plans, and tax laws change. Be sure to consult a qualified tax professional and an attorney before making any changes.

Business Tax Rates to be Aware of

Before reviewing the business structures below, it’s helpful to have the following in mind when comparing them and gauging what your tax liability would be:

• Income tax: If you are self-employed (sole proprietor, partnership, or a single/multi-member LLC), then you are responsible for paying income tax on your business’s net profit. Your quarterly estimated tax payments cover both your income and self-employment tax obligations.
• Self-employment taxes: If you are self-employed, you are also responsible for self-employment tax, which is commonly calculated as 15.3% and covers your contributions to Social Security and Medicare.
  • 12.4% goes to Social Security (applies to annual wages up to $176,100)
  • 2.9% goes to Medicare. You are liable for an additional 0.9% tax if your wages, compensation, or self-employment income exceed the threshold amount for your filing status.
  • Note: Self-employment tax is computed on 92.35% of net earnings. 
• Payroll taxes: If your business structure requires you to pay payroll taxes, they fund the same programs as self-employment taxes (15.3% total), but are split between employers and employees:
  • Employees pay 7.65% and employers pay 7.65%. 
  • Same as above, Social Security is taxed on income up to $176,100, and high-earning employees are responsible for an additional 0.9% Medicare tax.
• Corporate taxes (C-Corps only): C-Corps must pay federal income taxes on their profits (as of 2025, these are 21%), and depending on where you live, you may have to pay state corporate income taxes as well (check your state here). 

As we explore each structure below, you will see how these taxes apply.

The Five Most Common Business Structures

The most common business structures you will encounter are:

• Sole proprietorship:
• Partnership:
• Limited Liability Company (LLC)
• C Corporation
• S Corporation

We’ll examine each of these next, along with their tax treatment and pros and cons. 

Sole Proprietorship

Sole proprietorships are easy to set up and require minimal paperwork (often just a DBA at your local city hall). In the eyes of the IRS, a sole proprietorship is an unincorporated business owned and operated by a single founder. As a result, there is no distinction between the income your business generates and your personal income, which makes taxes quite simple. It also means that the owner is entitled to all the business profits and is responsible for all of the business’s debts, losses, and liabilities.

How Sole Proprietorships are Taxed

A sole proprietorship is considered a “pass-through entity,” meaning the business’s income is reported as part of the owner’s taxable income. That means your business income is reported on your personal tax return, and you are responsible for the following:

• Income tax
• Self-employment taxes

Sole proprietors are allowed to reduce taxable income through the following deductions:

• Deductible expenses: Sole proprietors can deduct expenses for their business, such as rent, utilities, office supplies, insurance premiums, travel, vehicle expenses, and even home office costs. Proper documentation of expenses is required in the event of an IRS audit.
• Qualified Business Income (QBI) Deduction: The Tax Cuts and Jobs Act (TCJA) allows eligible sole proprietors to deduct up to 20% of their qualified business income. This deduction has income thresholds, business-type limitations, and other complexities that require careful planning.

Your income should be reported on your 1040 with a Schedule C, and no separate business tax return is required.  Owners are required to pay estimated quarterly taxes if projected taxes exceed $1,000 per year.

While sole proprietorships are simple, they are rarely advantageous. They do not offer the tax savings that the structures below do, and because they offer no protection of personal assets, they expose you to unlimited liability, increasing your risk.

Learn more by visiting the IRS page on sole proprietorships.

Partnership

Like a sole proprietorship, a partnership is considered a “pass-through entity.” The key difference, obviously, is that partnerships are made up of two or more people. There are three types of partnerships:

• General Partnership (GP): All partners are general partners with management authority. Partners share the responsibility for the business’s debts and obligations, and income and losses are reported on the partners’ personal tax returns.
• Limited Partnership (LP): Includes general partners (see above) and limited partners who contribute capital but have limited liability.
• Limited Liability Partnership (LLP): Like the above, but it provides liability protection for all partners.

How Partnerships are Taxed

Your partnership profits and losses will be reported on your personal income tax return. The partnership agreement should govern the allocation of income, losses, and tax attributes among the partners. These allocations must reflect each partner’s economic interest in the business; otherwise, you risk IRS penalties.

General partners and active limited partners are subject to the following:

• Income tax
• Self-employment tax

Partners performing services for the partnership may receive guaranteed payments, which are similar to a salary. These are taxable income for the partner and are deductible for the partnership.

Like sole proprietorships, there are allowances for deductions:

• Deductions: You can deduct business expenses, travel, insurance, etc., though you must keep proper documentation.
• Losses: Partners can deduct their share of losses, but these deductions are limited to their basis in the partnership. Losses exceeding their basis are carried forward until their contributions or income increase.
• Qualified Business Income (QBI): Eligible partners may deduct up to 20% of their qualified business income (QBI) under the Tax Cuts and Jobs Act (TCJA).

General partners are also responsible for their share of taxes on profits, whether or not those profits have been distributed. Learn more by visiting the IRS page on partnerships.

Limited Liability Company (LLC)

Limited Liability Companies (LLCs) are where things start to get interesting. 

LLCs are designated by the IRS as “business structures allowed by state statute,” meaning that the rules around LLC formation and management can vary from state to state. Depending on the elections made by the LLC, the IRS may treat the LLC as a corporation, partnership, or sole proprietorship.

How LLCs are Taxed

This is the beauty of an LLC; you can choose the entity structure under the LLC to determine how it is taxed:

• Single Member LLC: Taxed like a sole proprietorship. All profits are treated as income and reported on your personal income tax return.
• Multi-Member LLC: Treated as a partnership. Partners receive Schedule K-1s and Form 1065 and report their share of profits and losses on their personal income tax return. 
• C-Corp Tax Treatment: The LLC is taxed as a separate entity and is responsible for paying federal taxes on profits, and members receive a W-2 for personal income tax reporting. You must pay payroll taxes on employee wages.
• S-Corp Tax Treatment: Unlike a C-Corp, the LLC is not taxed as a separate entity (no double-taxation). Members who actively work in the business must receive a “reasonable wage” as W-2 wages and must pay payroll taxes. But here’s the real advantage: distributions are only subject to income tax. More on this later in the S-Corp section.

By default, an LLC will be considered a pass-through entity; however, you are able to alter this and elect to be taxed as a C-Corp or S-Corp if you wish. Learn more about LLCs on the IRS website.

C Corporation

A C Corporation (C Corp) is one of the most complex business structures and is common for large companies or venture-funded companies. 

C-Corps are subject to “double-taxation,” meaning that the company pays corporate income taxes on its profits and its shareholders must pay income taxes on dividends and distributions. That said, C-Corps are attractive for their strong personal liability protection and the ability to sell shares of stock to raise capital. They also offer a wider range of business expenses that can be deducted, which can offset taxable income. 

C-Corps are more complex than the other structures in this article, and are made of the following groups:

• Shareholders: Owners of the corporation who hold shares of stock representing their stake.
• Board of directors: A group of individuals responsible for overseeing corporate governance.
• Officers/Executives: The company’s leadership team, including the CEO, CFO, and other C-suite executives.

How C Corporations are Taxed

Unlike the structures above, a C-Corp is taxed as an entity. That means you are responsible for:

• Federal taxes on profits (21% as of 2025) 
• Payroll taxes (15.3% split between the employer and employee)
• Shareholders in the business pay taxes on dividends 
• Employees and owners must pay taxes on W-2 earnings.

That said, C-Corps can retain earnings at a lower federal tax rate and access deductions that the structures above do not. Learn more about IRS taxation rules and requirements for corporations here.

Because C-Corps are not pass-through entities, they are not eligible for the Qualified Business Income (QBI) deduction under the Tax Cuts and Jobs Act (TCJA). You might think that C-Corps stand at a distinct disadvantage compared to some of the other entity structures in this list. While C-Corps suffer from double taxation, there is one key advantage to them: taxes when you sell. 

Thanks to “The One Big Beautiful Bill Act” (OBBBA), changes to Qualified Small Business Stock (QSBS) offer potential capital gains tax savings for qualifying C corporations. For QSBS acquired after July 4, 2025, there’s a tiered exclusion structure based on the holding period: 50% for over three years, 75% for over four years, and 100% for over five years. The exclusion cap increased to the greater of $15 million or 10 times the cost basis, and the corporate gross asset test threshold rose from $50 million to $75 million. 

This means that the longer you hold shares, the more you can make tax-free, and that more companies now qualify for this advantage.

S Corporation

An S-Corp is often seen as one of the most optimal business structures for tax purposes, and for good reason: S-Corps are not subject to double taxation like C-Corps and have a few unique advantages to boot. 

Like LLCs and partnerships, an S-Corp is a pass-through entity. But at the same time, while an S-Corp requires you to pay payroll taxes on wages, you do not pay payroll/self-employment taxes on distributions (profits taken from the business). This makes an S-Corp especially compelling, but note that there are several restrictions placed on them when compared to other entities:

• You cannot have more than 100 shareholders
• You can only have one class of stock
• You cannot have non-resident aliens as shareholders
• You must pay yourself a reasonable W-2 wage, and you are liable to penalties if the IRS believes you are not doing so

What is a “Reasonable Wage” for an S-Corp?

The IRS requires S-Corp shareholders who perform services for the corporation to receive “reasonable compensation” as W-2 wages before taking additional distributions. The compensation must be what would be paid to a third party for similar services under similar circumstances.

While the details are fuzzy, the IRS considers the following to determine whether owners are being paid enough:

• Geography
• Company size
• Industry
• Time devoted
• Company profitability
• Dividend history

Some professionals reference a “60/40” salary/distribution rule, but the IRS looks at market-rate compensation for your role, industry, size, and geography. Treat ratios only as very rough conversation starters, and not hard and fast rules. Learn more about compensation here.

How S Corporations are Taxed

S-Corp profits and losses flow to the shareholders’ personal tax return via K-1 forms. Shareholders must receive a reasonable W-2 wage, and are responsible for:

• Income tax (wages and distributions)
• Payroll tax (15.3% split between the business and employee).
  • Payroll tax only applies to income, and does not apply to distributions. 

S-Corps are eligible for the following deductions:

• Deductions: S-Corps must file an annual tax return using Form 1120S, which outlines the business’s financials. Each shareholder receives a Schedule K-1, detailing their share of the company’s income, deductions, and credits. 
• Qualified Business Income (QBI) Deduction: Owners and shareholders are eligible for the QBI deduction (up to 20% of their share of qualified business income), but this only applies to business net profits and not salaries paid to owners/shareholders.

The ability to both not be taxed as a business entity and receive distributions without paying payroll tax can provide significant self-employment tax savings compared to sole proprietorships or partnerships. Learn more about S-Corp taxation rules and requirements here.

The Advantages of Each Business Structure: Side-by-Side

Business Structure	Ownership	Pros	Cons
Sole Proprietorship	One person	Pass-through entity Simple/inexpensive business structure to set up Cost-effective to set up and manage Minimal reporting requirements No corporate business taxes	Unlimited personal liability Difficult to get business financing Perceived lack of credibility Growth constraints Requires accurate record-keeping
Partnership	Two or more people	Pass-through entity No corporate business taxes Simple/inexpensive business structure to set up	Unlimited personal liability (depending on partnership classification) Must create an official partnership agreement Difficult to raise capital Taxes are more complex than a sole proprietorship Taxed on income whether received or not
LLC	One or more people	Limited liability Flexible management structure No corporate business taxes Flexibility to choose tax structure	State-law entity; federal tax classification depends on IRS election (disregarded, partnership, or corporation). Foreign jurisdictions may treat LLCs differently.
C-Corp	One or more people	Limited liability Allows for an unlimited number of shareholders Preferred for IPO and outside investors Wider range of deductions High growth potential Perpetual existence	Double taxation More difficult and expensive to startIncreased regulation and oversight
S-Corp	1-100 people	Limited liability Pass-through entity No corporate business taxes Distributions are not subject to payroll taxes	Only 100 shareholders permitted Strict qualification standards Only recognized inside the U.S. Not recognized by all states

A Practical Example to Compare Each Structure

While the above is informative, it’s all theoretical. Let’s assume that you are the owner of a business that made $500,000 in profit this year. What could you expect to pay in taxes?

We’ll assume the following for this illustration:

• One owner who works full-time in the business
• 2025 federal tax rules
• 24% marginal income tax rate (to make things simple)
• No deductions, credits, or state/local taxes (again, to make things simple)

Note: The following is a rough calculation based on 2025 rates and takes many liberties in its assumptions. This is purely illustrative and should not be taken as exact figures or specific tax advice. For the sake of simplicity, we’ll also round all figures up to the nearest 1,000.

Sole Proprietorship

If a sole proprietorship generates $500,000 in income, you can expect the following for taxes:

• Income Tax: $120,000
• Self-Employment Tax: ≈ $38,000*
• Total Tax: ≈ $158,000

*Self-employment tax is applied to 92.35% of net earnings. Recall that the Social Security portion is capped at $176,100 for 2025. Half of your Self-Employment tax is deductible on your income tax return.

Partnership (Assuming Two Members)

Assuming a partnership of two in a business that generates $500,000, each partner’s share is $250,000, and they are responsible for the following:

• Income Tax (per partner): $60,000 each
• Self-Employment Tax (per partner): ≈ $29,000 each
• Total Tax (per partner): ≈ $89,000 each

LLC

Recall from above, an LLC can elect to be treated as a sole proprietorship, partnership, C-Corp, or S-Corp. If we assume that a single-member LLC generates $500,000 in profit and opts to be treated as a sole proprietorship, it will reflect the figures above:

• Income Tax: $120,000
• Self-Employment Tax: ≈ $38,000
• Total Tax: ≈ $158,000

If the LLC elects C-Corp or S-Corp taxation, its tax treatment will differ substantially (see below).

C-Corp

A C-Corp that generates $500,000 in profit will pay taxes at a corporate level, and the owner will pay taxes on dividends and income.

Corporate Level:

• Corporate income tax (21%): $105,000

If the remaining $395,000 is distributed as dividends to the owner:

• Total tax on dividends: ≈ $74,000
  • Dividend tax (15% qualified dividend rate): $59,000
  • Additional 3.8% Net Investment Income Tax (NIIT): $15,000

This gives us a total tax liability of $105,000 (corporate) + $74,000 (dividends) ≈ $179,000. And that’s ignoring the fact that you’d earn a W-2 wage and pay income and payroll tax on that as well.

S-Corp

Contrast a C-Corp to the following scenario for an S-Corp that generates $500,000 in profit. Let’s assume the same scenario: the owner absorbs all of that in a $200,000 salary with $300,000 in distributions.

• Income Tax: $120,000
• Payroll Tax on Salary: ≈ $27,000 (15.3% split between employer and employee; employer half is deductible)
• Self-Employment Tax on Distributions: $0
• Total Tax: ≈ $147,000

As you can see, an S-Corp has the lowest tax obligation of all five structures. Here’s a quick table breakdown of the above:

Structure	Profit	Corporate tax	Income tax	SE/Payroll Tax	Total Federal Tax
Sole proprietorship	$500,000	N/A	$120,000	≈ $38,000	≈ $158,000
Partnership (per partner)	$250,000	N/A	$60,000	≈ $29,000	≈ $89,000 (each)
LLC (sole member)	$500,000	N/A	$120,000	≈ $38,000	≈ $158,000
C-Corp	$500,000	$105,000	≈ $74,000 tax on dividends	N/A	≈ $179,000
S-Corp	$500,000	N/A	$120,000	≈ $27,000	≈ $147,000

By the numbers, there’s a clear advantage to an S-Corp (or LLC treated as an S-Corp) compared to the other structures. The ability to be treated as a pass-through entity while not paying payroll/self-employment taxes on distributions can lead to substantial savings, especially when compared to a C-Corp.

How to Choose the Right Business Structure for You

Should you go with an S-Corp for the tax savings? An LLC with S-Corp treatment? Or a C-Corp if you anticipate selling shares to a large number of investors?

Ultimately, the answer to this question is “it depends.” This is not purely a matter of taxes (though they play a large role); here are a few helpful things to consider as you decide:

• Company size: If you are the only employee/shareholder, a sole proprietorship or LLC makes a lot of sense given their ease of setup. That said, depending on your net profit, an LLC taxed as an S-Corp could be more advantageous. Larger companies with more shareholders or funding requirements may be better suited to a C-Corp or S-Corp.
• Revenue: If you are pre-revenue or treating the business as a hobby, then a sole proprietorship makes much more sense. For businesses generating higher income, an S-Corp or an LLC taxed as an S-Corp could make more sense.
• Location: Depending on where you live, the requirements for an LLC may be stricter or more expensive. Pay attention to your local laws.
• Capital requirements: Planning to raise capital? You may be required to form a Corporation (either C-Corp or S-Corp). 
• Your exit strategy: Lastly, it’s important to consider what you want to get out of your company while owning and exiting. The above entity structures will have tax implications for your exit, so take care to consider your goals for the future and not simply right now. Recall from earlier the new advantages C-Corps gain through the changes to OBBBA on selling your company.

The business structure you choose isn’t always just about taxes. You’ll need to consider the type of business you run, your anticipated growth, the size of your team,  your funding needs, plans to sell, and the tax implications. 

So, What is the Best Business Structure for Tax Purposes? 

The truth is, it depends.

We’ve covered quite a bit of ground in this article. You’ve learned what taxes you are responsible for as a business owner, how different businesses are taxed, and the pros and cons of each structure.

So which business structure is best? If you’re concerned about tax efficiency, then by the numbers, an S-Corp or LLC taxed as an S-Corp tends to offer the most tax savings by avoiding double-taxation while minimizing your self-employment tax burden. If you’re concerned about taxes when you exit the business, then a C-Corp offers unique advantages to minimize capital gains taxes on the sale.

If you can work within the restrictions and if your state recognizes it, an S-Corp can be a worthwhile strategy to pursue (or elect to have your LLC taxed as an S-Corp). But remember, the ‘best’ structure depends on your specific situation: business size, revenue level, growth plans, operational needs, and exit strategy. 

Take care and work with a qualified tax professional to make the right choice for you.

All of the above tax information is for information purposes only and is provided to explain the basic tax treatment based on the Internal Revenue Code. Any individual or entity considering any tax strategies should consult with their own CPA or tax/legal advisor who understands their particular tax circumstances and the rules governing their state. In no way is this information intended to be tax or legal advice.