Sole Proprietor, Partnership, S-Corp, or C-Corp: Which Is Best for Taxes?

One of the most common questions new business owners ask is:

“What type of business entity should I set up for tax purposes?”

The frustrating answer is: it depends.

The helpful answer is: understanding the basics will put you far ahead of most people.

This post is meant to be an introductory guide — not a final recommendation. We’ll walk through the most common entity types, how they’re taxed, and the major pros and cons of each. From there, you’ll be better equipped to ask the right questions before making a decision.

Why Entity Choice Matters More Than You Think

Your business structure affects:

• How much tax you pay
• Whether you owe self-employment tax
• How profits are reported
• How losses are used
• How assets are treated when sold
• How flexible your business is as it grows

Choosing the wrong entity doesn’t just mean paying a little extra tax — it can lock you into inefficiencies that compound year after year. Let’s take a look at the options:

Sole Proprietorship (The Default Option)

A sole proprietorship is the simplest structure. If you’re running a business by yourself and haven’t formally set up another entity, you’re already a sole proprietor.

How it’s taxed

• Income is reported on Schedule C of your personal return
• Net profit is subject to:
  • Income tax
  • Self-employment tax (Social Security + Medicare, ~15.3%)

Pros

• Simple and inexpensive
• No separate tax return
• Full control over the business
• Losses can offset other income

Cons

• Subject to full self-employment tax
• No separation between you and the business
• Limited tax planning opportunities

Important planning note

Sole proprietors do get benefits that are often overlooked:

• Step-up in basis at death
• Favorable treatment for appreciated assets (like land or equipment)
• Simplicity when winding down or selling

For many small or part-time businesses, a sole proprietorship is perfectly appropriate — especially in the early years.

Partnerships (Including Multi-Member LLCs)

A partnership is generally used when two or more people own a business together. For tax purposes, most multi-member LLCs default to partnership taxation.

How it’s taxed

• The partnership files an informational return (Form 1065)
• Income flows through to owners via K-1s
• Active partners typically pay:
  • Income tax
  • Self-employment tax on their share of earnings

Pros

• Flexible allocation of income and losses
• Pass-through taxation (no entity-level tax)
• Step-up in basis benefits
• Strong for real estate and appreciating assets

Cons

• Self-employment tax exposure
• More complex compliance
• Partner disputes can complicate tax outcomes

Where partnerships shine

Partnerships are often excellent for:

• Real estate investments
• Family businesses
• Asset-heavy operations
• Situations where flexibility matters more than payroll tax savings

They offer tax benefits that don’t always show up on the surface — especially related to basis and asset treatment.

S-Corporations (The Payroll Tax Strategy)

S-corps are often marketed as a “tax savings machine,” but the reality is more nuanced.

How it’s taxed

• The business files a separate return (Form 1120-S)
• Owners who work in the business must take:
  • Reasonable salary (subject to payroll taxes)
  • Remaining profits as distributions (not subject to self-employment tax)

Pros

• Potential savings on self-employment taxes
• Pass-through income (no corporate tax)
• Clear separation between wages and profits

Cons

• Reasonable salary requirements (IRS scrutiny)
• Additional compliance costs
• Limited flexibility in ownership and allocations
• Less favorable treatment for certain assets

The big misconception

An S-corp does not eliminate self-employment tax — it recharacterizes it. If your profits aren’t high enough to justify payroll costs and compliance, the “tax savings” may be negligible or nonexistent.

S-corps tend to make the most sense once:

• Profits are consistently above a certain threshold
• The owner is actively working in the business
• There’s room to pay a defensible salary

Another key point is the consideration of child wages. Sole-proprietorships and partnerships allow for child wages to be paid without paying any payroll taxes, but there is no option to avoid payroll tax for children in an S-Corp. A more complicated tax strategy that can be implemented,  is to pay child wages through a payroll partnership and having an operating S-Corp. There will be increased cost due to multiple tax returns and compliance fees, so it’s important to consider the tax savings before doing this. 

C-Corporations (The Flat-Tax Entity)

C-corps are less common for small businesses, but they shouldn’t be ignored.

How it’s taxed

• The corporation pays a flat 21% federal tax on profits
• Owners pay tax again when profits are distributed (dividends)

Pros

• Flat corporate tax rate
• No self-employment tax
• Attractive for reinvesting profits
• Ideal for certain growth or exit strategies

Cons

• Double taxation on distributions
• Less favorable for small owner-operated businesses
• More formalities and complexity

When a C-corp might make sense

C-corps are typically considered when:

• Profits are high and largely reinvested
• Owners don’t need regular distributions
• The business plans to scale or raise capital
• The owner’s personal tax rate is significantly higher than 21%

For many small businesses, C-corps aren’t the best fit — but for the right situation, they can be powerful. Again, in general there’s a certain amount of income that your business should generate before considering this option, but it’s good to have on your radar.

Key Tax Differences at a Glance

Here are some of the most important contrasts:

• Self-Employment Tax
  • Sole proprietors & partnerships: generally yes
  • S-corps: partially avoided via distributions
  • C-corps: no

• Basis & Asset Treatment
  • Sole props & partnerships: strong flexibility
  • S-corps: more restrictive
  • C-corps: entity owns the assets

• Complexity
  • Sole prop: low
  • Partnership: moderate
  • S-corp: moderate to high
  • C-corp: high

Final Thoughts (and a Big Caveat)

There is no universally “best” entity for taxes.

The right choice depends on:

• Profit level
• Type of income
• Assets owned
• Growth plans
• Risk tolerance
• Long-term exit strategy

This post is meant to give you a framework, not a final answer.

If you’re operating a business — or planning to — entity selection is one area where good advice pays for itself. A small decision early can have massive tax consequences over time.

If you’d like a second opinion, are considering a change, or want help modeling different scenarios, feel free to reach out. For quick, high-level questions, I’m often happy to help informally. For more complex situations that require deeper analysis, we can discuss scope and pricing upfront.

Getting this right matters — and it’s worth doing intentionally.

– Brendan Tiedeman, CPA, CVA