S-Corp vs. LLC: Taxes & How Owners Get Paid

"How do I pay myself?" is one of the most common questions new owners have — and the honest answer is: it depends entirely on your business structure. Get this wrong and you're not just making an accounting mistake, you can trigger real IRS penalties. Here's how it actually works for each structure.

Sole proprietorship or single-member LLC (no S-Corp election): You take an owner's draw — you simply transfer money from the business account to yourself whenever you want. There's no payroll, no withholding. You pay tax on the business's total profit at the end of the year regardless of how much you actually drew out.

Partnership or multi-member LLC: Same idea, but split among partners according to your operating agreement — these are called partner draws or distributions.

S-Corp (an election, not a separate entity): This is where it changes. You're required to pay yourself a W-2 salary through payroll — with normal tax withholding, just like an employee — and you can take any remaining profit as a distribution, which isn't subject to payroll tax. This split is exactly what creates the tax savings covered below, and exactly why the IRS pays close attention to it.

C-Corp: Same W-2 salary structure as an S-Corp, but instead of pass-through distributions, remaining profit can be paid out as dividends — which are taxed differently (see the double-taxation section below).

By default, the IRS doesn't see an LLC as its own tax category — it "looks through" the LLC to the owner. A single-member LLC is taxed exactly like a sole proprietorship; a multi-member LLC is taxed like a partnership. In both cases, all of the business's net profit is subject to self-employment (SE) tax — currently 15.3%, covering Social Security and Medicare — on top of your regular income tax. That 15.3% applies whether you actually withdrew the money or left it in the business account.

Why 15.3%, and why it doesn't matter whether you withdrew the cash: A regular employee's paycheck funds Social Security and Medicare through a 7.65% employee-side FICA tax, matched by another 7.65% their employer pays on their behalf — 15.3% total, split two ways. When you're self-employed, there's no separate "employer" to pay the other half — you're both, so you owe the full 15.3% yourself. And the tax is on profit the business earned, not on what you personally spent — the same way a regular employee owes tax on wages earned, not on however much of their paycheck they happened to spend that month. This is the thing that surprises a lot of first-year LLC owners: a profitable side business can generate a real tax bill even if you reinvested every dollar back into the business and never personally spent a cent of it.

Electing S-Corp taxation doesn't change your liability protection or your day-to-day operations — it only changes how the IRS taxes your profit. The mechanism is straightforward: you split your net profit into a W-2 salary (subject to payroll tax) and a distribution (not subject to payroll tax). Since payroll tax only applies to the salary portion, splitting profit this way can meaningfully lower your total tax bill — but only once you're profitable enough that the payroll administration cost (typically a few hundred dollars a year for a payroll service, plus your accountant's time) is worth it. Most advisors put that breakeven point somewhere around $40,000–$60,000 in net profit, though it depends on your specific numbers — run the calculator below with your own figures.

Why the reasonable-salary rule exists at all: Social Security and Medicare are funded by payroll tax on wages — that's the entire mechanism. If an S-Corp owner could simply pay themselves $0 salary and take everything as a distribution, they'd get all the benefit of running the business while contributing nothing to the system that (among other things) funds their own future Social Security and Medicare benefits — and every other S-Corp owner would have the same incentive to do the same thing. "Reasonable salary" is the rule that closes that gap: you can still get the legitimate tax benefit of the salary/distribution split, but you can't use the split to opt out of the payroll-tax system entirely. It's an anti-abuse rule protecting the funding mechanism, not an arbitrary hoop.

Why only one class of stock is allowed: The same logic extends to ownership. If an S-Corp could issue different classes of stock — one with a bigger claim on profit, one with voting rights but no economic stake, and so on — owners could effectively route profit however they wanted regardless of actual ownership percentage, which defeats the simple, strictly-proportional pass-through system Congress designed Subchapter S around in the first place. One class of stock keeps "your percentage of ownership = your percentage of profit and loss" true without exception, which is also exactly why most venture capital deals (which use preferred stock with special rights) are structurally incompatible with S-Corp status.

The tax savings are only half the picture, though. An S-Corp election also comes with real eligibility restrictions that can disqualify you or trip you up later — a 100-shareholder cap, ownership limited to U.S. individuals and certain trusts/estates (no companies, partnerships, or non-U.S. investors), and time limits on trust ownership after the original owner's death. See "Why You Might NOT Choose Each Structure" in the Choosing Your Business Structure module for the full list before you file the election.

A C-Corp is the one structure that isn't pass-through — the company itself pays corporate income tax on its profit, and then if any of that profit is distributed to owners as dividends, the owners pay tax on it again on their personal return. This is what people mean by "double taxation," and it's the main tax tradeoff founders accept in exchange for the structure that institutional investors require (see Module 1).

Why this happens, structurally: A C-Corp is a genuinely separate legal "person" under the law — not a pass-through label, an actual distinct taxpayer with its own income. The ordinary rule in the tax code is that income is taxed to whoever receives it. The corporation receives income and is taxed on it; when it then pays some of that already-taxed income out to a shareholder as a dividend, the shareholder has also received income, under that same ordinary rule. An LLC or S-Corp avoids this by a specific pass-through election that says "don't tax the entity itself, only the owner" — a C-Corp simply doesn't have that election. Double taxation isn't a penalty for choosing C-Corp; it's what happens by default any time two separate legal persons both receive income from the same dollar, which is exactly the trade-off you're accepting in exchange for the corporate structure institutional investors require.

There's one major exception worth knowing about if you're a C-Corp founder or early employee: Qualified Small Business Stock (QSBS), under Section 1202 of the tax code, can let you exclude a large portion — potentially all — of your capital gain when you eventually sell qualifying stock, if you meet specific requirements around how long you've held it and how the company is structured. The rules here are detailed, they were significantly changed by recent tax legislation, and eligibility depends on facts specific to your company (industry, asset size, when the stock was issued). This is genuinely one of the highest-value provisions in the tax code for startup founders and early employees — and also one of the easiest to accidentally disqualify yourself from without knowing it. Talk to a startup-experienced CPA or attorney about QSBS eligibility before you need it, not after — some of the requirements depend on decisions made at the time stock is issued, which is too late to fix retroactively.