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What’s the right entity type for your new business?

One of the first decisions you’ll make when starting a business is choosing a legal structure. The entity you choose affects how your business is taxed, your personal liability, and how your business operates.

If you’re starting a business with one or more partners, two popular options are a multimember LLC taxed as a partnership or an S corporation. Both are pass-through entities, meaning the business’s income, deductions, gains, losses, and credits pass through to the owners and are reported on their personal federal income tax returns. Both also provide liability protection.

While these business structures share many similarities, there are important differences that can affect your taxes and long-term flexibility.

At a glance: In general, LLCs offer more flexibility, while S corporations may provide self-employment tax savings for some business owners. The right choice depends on your specific circumstances.

Multimember LLCs

A multimember LLC combines the liability protection of a corporation with the pass-through taxation of a partnership.

One of the biggest advantages is personal liability protection. If your business is sued or owes money, your personal assets, such as your home or personal savings, are generally protected under state law. Another benefit is that all LLC members can help manage the business without giving up that liability protection.

For federal tax purposes, profits and losses pass through to the owners. This means the LLC generally doesn’t pay federal income tax. Instead, each member reports their share of the business’s income, deductions, gains, losses, and credits on their personal tax return.

In addition to income tax, LLC members may also owe self-employment tax. For 2026, this includes:

• Social Security tax of 12.4% on the first $184,500 of self-employment income
• Medicare tax of 2.9% on all self-employment income

The good news is that you can deduct half of your self-employment tax on your federal income tax return.

It’s also important to know that not every business can operate as an LLC. Depending on your state, certain licensed professions may face restrictions under state law or professional licensing rules.

S Corporations

An S corporation is a corporation that elects a special federal tax status. Like an LLC, it offers liability protection and pass-through taxation, meaning business income generally flows through to the owners’ personal tax returns instead of being taxed at the corporate level.

One of the biggest tax advantages of an S corporation is that shareholder-employees generally don’t pay self-employment tax on all business profits. Instead, they must receive “reasonable” compensation that’s subject to Social Security and Medicare taxes. Any additional profits distributed to shareholders generally aren’t subject to self-employment tax.

However, S corporations aren’t always the better choice. In several areas, LLCs taxed as partnerships provide greater flexibility.

For example:

• Deducting losses. LLC owners may be able to deduct more business losses because their tax basis can include certain business liabilities. S corporation shareholders generally receive additional basis only from money they personally lend to the corporation.
• Buying into the business. When someone purchases an ownership interest in an LLC, they may receive a step-up in the tax basis of the LLC’s assets. This can reduce taxes if those assets are later sold or converted to cash.
• Transferring assets. LLCs generally have greater flexibility when transferring assets, including cash, between the business and its owners without triggering taxes.

LLCs also have more flexibility in how they allocate taxable income, losses, and certain other tax items among owners. S corporations, by contrast, must allocate all pass-through tax items strictly according to each shareholder’s ownership percentage.

It’s also worth noting that not every business qualifies to elect S corporation status. To maintain S corporation status, businesses must meet IRS requirements that limit the number and types of shareholders, prohibit certain ownership structures, and impose other restrictions.

Making the right choice

Choosing the right business structure is one of the most important decisions you’ll make as a business owner. While both LLCs and S corporations can offer valuable tax advantages, the best choice depends on your business, your goals, and your long-term plans.

Before making a decision, consult with us. We’ll work with you and your legal advisors to determine which business structure best fits your situation and helps position your business for long-term success.

Find your local Padgett office here!

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