LLC vs. Sole Proprietor: What the Tax Difference Actually Means

Last updated July 2, 2026

A single-member LLC is treated as a disregarded entity for federal income tax purposes by default, which means the IRS taxes it identically to a sole proprietorship. All net income flows through to the owner's personal return on Schedule C and is subject to self-employment tax at 15.3 percent on the first $184,500 of net earnings and 2.9 percent above that. The LLC designation alone provides no federal tax advantage over sole proprietorship. The liability protection an LLC provides is real and valuable, but it is a legal benefit, not a tax benefit.

The tax difference appears when an LLC elects to be taxed as an S corporation. An S election allows the owner to split income between a reasonable salary, which is subject to payroll taxes, and a distribution, which is not. A sole proprietor with $150,000 in net income pays self-employment tax on the full amount. An LLC taxed as an S corporation can pay the owner a reasonable salary of $80,000 and take $70,000 as a distribution, saving the 15.3 percent self-employment tax rate on approximately $70,000 — roughly $10,000 in annual FICA savings, minus the cost of payroll administration and S corporation filing requirements. The S election makes sense when net income is consistently above $60,000 to $80,000 annually, which is where the tax savings exceed the administrative costs.

The LLC itself creates no federal tax savings over sole proprietorship. The tax planning opportunity comes from electing S corporation treatment, which requires paying yourself a reasonable salary while taking the remainder as distributions not subject to payroll taxes. Consult a CPA before making the S election to confirm the break-even analysis works for your income level and that reasonable compensation requirements are properly understood.