How to Choose the Right Tax Setup for LLC

If you’ve already read my blog about why you shouldn’t wait to form your LLC, you know this is one of the first foundational moves I recommend.

In my 10 Steps to Starting a Business framework, forming your LLC comes right after planning and choosing your name.

But once your name is locked in? Step 3 is separating yourself from your business legally by setting up your LLC.

That legal separation is huge. But here’s what most people don’t realize: how you’re taxed as an LLC is a completely separate decision.

And that decision, whether to stay taxed as a sole proprietor or elect S-Corp status, can make a major difference in how much money you keep in your pocket.

Let’s break it down clearly (and in plain English).

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1. Starting Out: Why Most LLCs Are Taxed Like Sole Proprietors

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When you first form an LLC, you’re not automatically taxed as a corporation.

By default, if you're a single-member LLC, the IRS treats you as a sole proprietor. If you have multiple members, it’s treated as a partnership.

What this means:

• You don’t file a separate business tax return.
• You report your income and expenses on your personal tax return (usually on a Schedule C).
• You pay self-employment tax on your profits.

For most brand-new business owners, this default setup works perfectly fine, and is typically what I recommend my clients stick to in the beginning. It’s simple, it’s straightforward, and it keeps startup admin low while you get your feet under you.

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2. When It’s Time to Consider an S-Corp Election

Once your business starts bringing in consistent *profit* — think $50K to $75K+ after expenses — that simplicity can start to cost you.

Why? Because as a sole proprietor, you’re paying self-employment tax on 100% of your business profit. That adds up fast.

Here’s where the S-Corp election comes in.

You can elect to have your LLC taxed as an S-Corp by filing IRS Form 2553.

This lets you split your income into two parts:

• A reasonable salary, which is subject to self-employment tax, and
• Distributions, which are not.

The result? Less tax burden on your overall income  and potentially thousands of dollars saved.

But here’s the key: you shouldn’t jump into this too early.

An S-Corp setup comes with more admin and compliance — including running payroll for yourself and filing a separate business tax return. For many business owners, it’s not worth the added cost or complexity until they’re consistently profiting well above that $50K+ threshold.

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3. Pros and Cons of Electing S-Corp Status

✅ Pros:

• Big savings on self-employment tax once your income is high enough.
• Lets you pay yourself a regular paycheck (which can help with personal budgeting and financing).
• Can enhance your business’s credibility with lenders and investors.
  
  

⚠️ Cons:

• More admin: You’ll need to run payroll (yes, even if it’s just you).
• Separate tax return required (Form 1120S).
• May need to hire an accountant or payroll provider — which comes with extra cost. (I highly recommend hiring an accountant, or at minimum a bookkeeper, if you are electing to file taxes as a S-Corp, or are an incorporated business of any kind.)

It’s not for everyone, and it’s definitely not something to rush into right out of the gate, but when the time is right, it can be a smart strategic move.

Final Thoughts

Forming your LLC is Step 3 in my business-building framework for a reason: it’s foundational.
It protects you legally, boosts your credibility, and creates a clean break between you and your business.

But what comes after that matters just as much, especially when it comes to taxes.

Sticking with default sole proprietor taxation is usually the right call early on. But once you start generating solid, consistent profit, electing S-Corp status can be a powerful way to keep more of what you earn.

The key is knowing when the time is right and being proactive about it.

If you’re unsure, talk to a CPA who actually works with small businesses. Not every tax pro is created equal, and you want someone who understands solopreneurs, service providers, and the self-employed.

Disclaimer: I’m not a lawyer or an accountant. This is based on my personal experience operating and advising businesses, and it’s meant to give you a real-world perspective — not legal or tax advice. Please consult a qualified professional for guidance specific to your situation.

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