The Entity Decision That Could Save—or Cost—You Thousands

When you started your business, you made a choice about how to structure it. Maybe you filed as a sole proprietor because it was simple. Maybe you formed an LLC on the advice of a friend. Maybe an attorney set up an S Corporation without much discussion of alternatives.

That decision made sense at the time—or at least it seemed to. But businesses evolve. Revenue grows. Circumstances change. Tax laws shift. And the entity structure that worked when you were generating $150,000 in revenue may be costing you significant money now that you’re at $500,000 or beyond.

Most business owners never revisit their entity structure after the initial formation. That’s a mistake. A periodic review of whether your current structure still serves your goals can reveal opportunities to reduce taxes, protect assets, and position your business for future growth or transition.

Why Entity Structure Matters

Your business entity structure affects virtually every aspect of your financial life as a business owner. It determines how your business income is taxed—whether at the entity level, on your personal return, or some combination. It affects your exposure to self-employment taxes on business profits. It influences your personal liability for business debts and legal claims. It impacts your ability to raise capital, bring in partners, or eventually sell the business. And it determines the complexity and cost of compliance, from annual filings to record-keeping requirements.

Choosing the wrong structure—or staying in a structure you’ve outgrown—can result in paying thousands of dollars more in taxes than necessary, carrying more personal risk than you realize, and limiting your options when opportunities arise.

Common Business Structures and Their Implications

Sole Proprietorship

The simplest structure—and the default if you haven’t formally organized your business. You report business income and expenses on Schedule C of your personal tax return. All net business income is subject to both income tax and self-employment tax (currently 15.3% on earnings up to the Social Security wage base, plus 2.9% Medicare tax on amounts above that threshold).

Sole proprietorships offer simplicity but provide no liability protection. Your personal assets are fully exposed to business creditors and legal claims. And the self-employment tax burden can become significant as profits grow.

Single-Member LLC

A single-member LLC is treated as a “disregarded entity” for federal tax purposes—meaning it’s taxed the same as a sole proprietorship unless you elect otherwise. You still report income on Schedule C, and all profits remain subject to self-employment tax.

The advantage over sole proprietorship is liability protection. Properly maintained, the LLC creates a legal separation between business and personal assets. But the tax treatment is identical unless you make an affirmative election.

Partnership and Multi-Member LLC

When two or more owners operate a business together, the default structure is a partnership (or a multi-member LLC taxed as a partnership). The business files an informational return (Form 1065), but profits pass through to the individual partners, who pay tax on their share regardless of whether cash is distributed.

Partnership taxation offers flexibility in allocating income, losses, and distributions among partners. But it also creates complexity, particularly around guaranteed payments, self-employment tax treatment, and basis tracking.

S Corporation

An S Corporation is a tax election—not a type of legal entity. An LLC or corporation can elect S Corp treatment by filing Form 2553 with the IRS. The S Corp files its own tax return (Form 1120-S), but profits pass through to shareholders’ personal returns.

The key advantage of S Corp taxation is the potential to reduce self-employment taxes. S Corp shareholders who work in the business must pay themselves a “reasonable salary,” which is subject to payroll taxes. But profits above that salary can be distributed as dividends, which are not subject to self-employment or payroll tax.

For profitable businesses, this structure can generate meaningful tax savings. But it also adds complexity: payroll administration, reasonable compensation analysis, and strict requirements around distributions and basis.

C Corporation

A C Corporation is a separate taxpaying entity. The corporation pays tax on its profits at the corporate tax rate (currently a flat 21%), and shareholders pay tax again when profits are distributed as dividends. This “double taxation” makes C Corps unattractive for most small businesses.

However, C Corps offer advantages in specific situations: when you’re planning to raise outside investment, when you want to retain significant earnings in the business at the lower corporate rate, or when you qualify for the Qualified Small Business Stock (QSBS) exclusion, which can eliminate up to $10 million in capital gains when you eventually sell.

Signs Your Current Structure May No Longer Fit

You’re Paying Significant Self-Employment Tax

If you’re operating as a sole proprietor or single-member LLC and your net business income exceeds $75,000 to $100,000, you may be paying more self-employment tax than necessary. S Corporation election could allow you to pay yourself a reasonable salary—say, $60,000 to $80,000 depending on your role—while taking additional profits as distributions not subject to self-employment tax.

The savings can be substantial. A business owner with $150,000 in net profit who converts from sole proprietorship to S Corp and pays a $75,000 salary could save $10,000 or more annually in self-employment taxes. The exact savings depend on your specific situation, and the administrative costs of S Corp compliance reduce the net benefit—but for many profitable businesses, the math is compelling.

Your Business Has Grown Substantially

What made sense at $100,000 in revenue may not work at $1 million. Growth changes everything: your tax situation, your risk exposure, your financing needs, and your eventual exit options.

Businesses at scale often benefit from structures that facilitate bringing in investors or partners, protect accumulated assets from operational risk, allow for more sophisticated compensation and benefit arrangements, and position the business for eventual sale.

You’re Planning to Bring in Partners or Investors

Adding partners or investors requires a structure that can accommodate multiple owners with potentially different economic arrangements. Converting from a sole proprietorship to a partnership or multi-member LLC—or restructuring an existing entity to accommodate new ownership—requires advance planning.

If outside investment is on your horizon, understanding what investors expect (many prefer to invest in C Corps or LLCs rather than S Corps due to tax considerations) helps you prepare appropriately.

You’re Thinking About Selling the Business

How your business is structured affects both the mechanics and the tax consequences of an eventual sale. Asset sales versus stock sales have dramatically different tax implications. S Corps face limitations on who can be shareholders that may complicate certain transactions. C Corps may offer advantages through QSBS treatment if properly structured from the beginning.

Planning for a sale that may be years away allows you to position the business optimally, rather than scrambling to restructure when a buyer appears.

Your Personal Circumstances Have Changed

Marriage, divorce, estate planning considerations, and changing asset protection needs can all affect the optimal business structure. A structure that made sense when you were single with few assets may be inappropriate now that you have a family, a home, and other investments to protect.

The Restructuring Process

Changing your entity structure is possible but requires careful execution. Some changes are straightforward—electing S Corp treatment for an existing LLC, for example, requires only filing Form 2553 by the deadline. Other changes, like converting from a sole proprietorship to a corporation, involve creating a new entity and transferring assets.

Some restructuring triggers immediate tax consequences. Others can be accomplished tax-free if structured properly. Understanding the implications before you act is essential.

The process typically involves analyzing your current situation and goals, modeling the tax impact of different structures, evaluating non-tax considerations like liability protection, administrative burden, and future flexibility, selecting the optimal structure, executing the transition properly including all legal filings and asset transfers, and implementing new compliance procedures for the new structure.

The Cost of Inaction

Many business owners suspect their current structure isn’t optimal but never get around to addressing it. The result is ongoing overpayment of taxes—not a one-time cost, but a recurring drain that compounds year after year.

A business owner overpaying $8,000 annually in self-employment taxes due to suboptimal structure will pay $40,000 over five years, $80,000 over ten years. That’s money that could be reinvested in the business, contributed to retirement accounts, or simply kept in your pocket.

When to Have the Conversation

If any of the following apply to you, it’s worth evaluating whether your current structure still serves your goals: your net business income exceeds $75,000 to $100,000 annually, your revenue has doubled or more since you chose your current structure, you’re considering bringing in partners or investors, you’re thinking about selling the business in the next five to ten years, your personal circumstances have changed significantly, or you’ve never actually evaluated whether your structure is optimal.

A conversation about entity structure isn’t a commitment to change anything. It’s simply an opportunity to understand your options and make an informed decision about whether your current setup still makes sense.