Is Your Business Structure Costing You More Than You Think?

Choosing the right business structure is about more than just filing paperwork with your state. The entity type you select—sole proprietorship, limited liability company, partnership, S corporation, or C corporation—has long-term financial, tax, and operational implications. And if you’re not careful, sticking with the wrong structure could be costing you more than you realize.

Photo by Declan Sun on Unsplash

Below, we’ll break down the different options, highlight the costs tied to each, and show where strategic restructuring could save you money.

Common Business Structures and Their Costs

Here’s a look at the most common ways to structure a business and what each one can mean for your taxes, compliance obligations, and overall costs.

Sole Proprietorship

A sole proprietorship is the simplest way to run a business because it’s just you and your work. There’s no separate legal entity, so all profits flow directly to your personal tax return. That simplicity comes with a price, though.

You’ll pay self-employment taxes of 15.3% on every dollar of net income, which can add up quickly. Plus, there’s no liability shield, meaning your personal assets could be at risk if something goes wrong. For very small operations or freelancers, this setup can work just fine, but it often becomes costly as your business grows.

Partnership

A partnership is often the starting point when two or more people go into business together.  Income and expenses pass through to the partners’ personal returns, so there’s no tax at the entity level. Each partner, however, pays self-employment tax on their share of income, which can be significant. Partnerships also require a separate tax return, Form 1065.

Partnerships can get complicated if the ownership split or responsibilities aren’t clearly spelled out in an agreement. And like a sole proprietorship, there’s no liability shield. Still, for small businesses with multiple owners who value flexibility, this business structure can be a solid option.

Limited Liability Company (LLC)

An LLC adds an extra layer of protection by separating your business from your personal assets. That liability protection is one reason many small business owners choose it, but it doesn’t automatically come with tax savings.

By default, the IRS treats a single-member LLC like a sole proprietorship for tax purposes and taxes multi-member LLCs like partnerships. That means you still pay self-employment tax on profits unless you make an election to be taxed differently.

On top of that, states typically require annual filing fees that can range from modest to quite expensive. Arkansas is the least expensive state in the U.S., with LLC fees of $45 per year, while Massachusetts is the most costly, at $520 per year to maintain an LLC, according to Wolters Kluwer.

The upside is flexibility. With an LLC, you can decide later whether it makes sense to be taxed as an S Corp or even a C Corp.

S Corporation (S Corp)

An S corporation isn’t actually a different type of business structure. It’s a tax election that an LLC or corporation can make. The big advantage here is how the owners pay taxes on business profits.

Owners pay themselves a reasonable salary that’s subject to payroll taxes, but they can take the rest of the profits as distributions, which aren’t hit with self-employment tax. This can translate into real savings.

But it’s not free money. You’ll face extra compliance requirements, like running payroll, filing a separate S Corp tax return, and keeping up with corporate formalities. Below, we run the numbers to show you how we help clients make the decision.

C Corporation (C Corp)

A C corporation is a completely separate entity from its owners, taxed at the corporate level with a flat 21% federal tax rate. That might sound appealing, especially if your personal tax bracket is higher, but there’s a catch: dividends distributed to shareholders are taxed again on personal returns. This “double taxation” is the main drawback for small business owners.

On the other hand, C corps are often the right choice for companies planning to raise investor capital or reinvest most of their profits back into the business. For example, $200,000 in taxable income would face a top tax rate of 32% if passed through to an individual, but only 21% inside a C Corp. That potentially frees up more cash for growth. The tradeoff is more administrative work, including annual meetings, minutes, and corporate tax returns.

Why It’s Not a One-Size-Fits-All Decision

You may see social media accountants promoting S Corp elections as a tax-savings “hack.” While an S Corp can be beneficial in the right situation, it’s not the right fit for everyone. Factors like your income level, the need to reinvest profits, state-level taxes, and administrative costs all play a role.

For example, if your business income fluctuates, the payroll obligations of an S corporation could be more of a burden than a benefit. If you need health insurance or plan to raise outside capital, a C Corp might align better. If you’re just starting out and aren’t generating much profit, the added compliance costs of a corporation could outweigh the savings.

The bottom line is that every business is unique. What works for one owner could cost another more in the long run.

S Corp Tax Savings Example

Say your business generates $120,000 in profits. As a sole proprietor or single-member LLC, your self-employment tax bill would be $16,955.46.

Why that figure? According to the IRS, the amount of sole proprietorship or LLC profits subject to self-employment tax is 92.35% of your net earnings from self-employment. Here’s the math:

$120,000 x .9235 x 15.3% = $16,955.46

Now, say you make an S Corp election and pay yourself a salary of $70,000. Now, your self-employment tax bill would be $10,710. As an S Corp owner, you pay self-employment taxes on your entire salary:

$70,000 x 15.3% = $10,710

At first, it seems like a no-brainer to make an S Corp election, as your self-employment tax burden would be $6,245.46 lower. However, it’s not all free money. You’ll face extra compliance requirements, like running payroll, filing a separate S Corp tax return, and keeping up with corporate formalities. The IRS also watches closely to ensure you pay yourself a “reasonable salary,” so you can’t save more by paying yourself a tiny salary and taking the rest in distributions. It’s important to strike the right balance.

Also, this simple illustration doesn’t take into account the qualified business income deduction or state and local taxes. That’s why it’s crucial to work with an advisor who can run the numbers, taking into account cash flow, payroll costs, additional tax filings, and a reasonable salary.

The Right Next Step

Before making changes to your business structure, talk with an advisor who can model the tax impact, weigh compliance costs, and help you determine if a change will truly save you money.

At Slate, we help business owners navigate these decisions every day. If you’re wondering whether your current structure is costing you more than it should, contact Slate to schedule a conversation.