How to Save Money on Taxes by Structuring Your Small Business Correctly

Choosing the right business structure isn’t just about legal protection—it can also make a major difference in how much you pay in taxes. Small business owners who understand the tax implications of their business entity can take advantage of strategic savings that add up year after year.

In this guide, we’ll walk through how different business structures affect your tax obligations and help you determine which one is best for maximizing your tax efficiency and minimizing your financial burden.

Why Business Structure Matters for Taxes

Your business structure determines:

How you report income and expenses to the IRS
The types of taxes you pay (income, self-employment, payroll, etc.)
Whether your business income is taxed once or twice
Which tax deductions and credits you qualify for
Your personal liability for business debts and obligations

A poor choice of structure could mean overpaying taxes, missing out on deductions, or exposing yourself to unnecessary risk. Let’s explore your options.

1. Sole Proprietorship: Simple but Costly for Taxes

A sole proprietorship is the easiest and most affordable business type to form. You don’t need to register with the state (except for permits or a DBA), and all income and expenses flow through your personal tax return.

Tax considerations:

You’ll pay income tax on all profits.
You’re subject to self-employment tax (15.3%) on net earnings.
Limited tax flexibility—no way to split income or defer taxes.

Best for: Very small businesses, freelancers, and side hustlers just starting out.

Savings tip: Deduct all business-related expenses to reduce your taxable income, but consider switching structures as income grows.

2. Partnership: Shared Taxes, Shared Liability

If you co-own a business with one or more people, a partnership is the default structure. Like sole proprietorships, partnerships are pass-through entities.

Tax considerations:

The partnership itself files Form 1065, but doesn’t pay tax.
Each partner receives a Schedule K-1 showing their share of income.
Each partner pays income and self-employment tax on their portion.

Best for: Small businesses with two or more owners who want simple pass-through taxation.

Savings tip: Partners can split income and losses strategically based on their ownership percentage and roles in the business.

3. Limited Liability Company (LLC): Flexible and Tax-Efficient

An LLC offers legal protection like a corporation but can be taxed in multiple ways.

Default taxation:

Single-member LLC: taxed like a sole proprietorship
Multi-member LLC: taxed like a partnership

Other options:

Elect to be taxed as an S Corporation or C Corporation to reduce taxes

Benefits:

Pass-through taxation avoids double taxation
Flexibility in how profits are distributed
Legal protection for owners' personal assets

Best for: Small business owners who want liability protection and tax flexibility.

Savings tip: Consider electing S Corp status (via IRS Form 2553) to reduce self-employment taxes (explained more below).

4. S Corporation (S Corp): Pay Yourself a Salary and Save

An S Corp is not a business entity itself, but a tax status that LLCs or corporations can elect. It offers one of the best opportunities for tax savings if your business is profitable.

Tax advantages:

Avoids double taxation (no corporate income tax)
Owners can receive both a reasonable salary and profit distributions
Distributions are not subject to self-employment tax

Example: If you earn $100,000:

Pay yourself a $60,000 salary (subject to payroll taxes)
Take $40,000 as a distribution (not subject to self-employment tax)
This could save thousands in taxes

Requirements:

Must pay yourself a “reasonable salary” as defined by the IRS
Must file additional forms and run payroll

Best for: LLCs or small corporations with steady profits who want to reduce self-employment tax.

Savings tip: Consult a CPA to determine if switching to an S Corp will save you money based on your income and business type.

5. C Corporation: Strategic Tax Deferral and Fringe Benefits

A C Corporation is a separate legal and tax entity. While it pays corporate income tax, it also opens up advanced planning strategies.

Tax characteristics:

Subject to corporate tax (21% as of 2024)
Double taxation on dividends (corporation and shareholder pay taxes)
Unlimited growth potential and fundraising opportunities

Advantages:

Can retain earnings in the business for future growth
More fringe benefit options (health insurance, retirement, etc.)
Lower corporate tax rate may be beneficial at certain income levels

Best for: Larger businesses planning to scale or raise capital, or those wanting access to advanced tax planning.

Savings tip: Use retained earnings to reinvest in the business and avoid dividend taxation. Also, offer tax-deductible benefits to owners and employees.

Comparing Tax Impacts of Different Structures

Business Structure	Tax Filing	Subject to Self-Employment Tax?	Double Taxation?	Ideal for Tax Savings?
Sole Proprietorship	Schedule C (Form 1040)	Yes	No	Limited
Partnership	Form 1065 + K-1	Yes	No	Moderate
LLC (Default)	Same as Sole/Partner	Yes	No	High (w/S Corp election)
S Corporation	Form 1120S + K-1	No (on distributions)	No	Very High
C Corporation	Form 1120	No	Yes	High (with planning)

Key Tips to Structure Your Business for Tax Savings

Don’t default to sole proprietorship without evaluating options.
- It’s easy, but potentially costly as you grow.
Use an LLC for legal protection, then elect S Corp when profitable.
- Best of both worlds for many small businesses.
Keep clear records and run payroll properly for S Corps.
- Avoid IRS penalties by paying yourself a fair wage.
Plan ahead before switching to a C Corp.
- Weigh the tax benefits against complexity and double taxation.
Reevaluate your structure regularly.
- As your business grows, your structure should evolve too.

When to Consult a Tax Professional

Structuring your business to save money on taxes isn’t one-size-fits-all. The right setup depends on your industry, income level, business goals, and more. A tax advisor or CPA can help you:

Choose the ideal business entity for your situation
Calculate potential tax savings with different structures
Assist with IRS forms and state filings
Keep you compliant with payroll and distribution rules

The cost of expert guidance is often far less than the savings you’ll gain by making smarter tax decisions.

Final Thoughts: Structure Smarter, Save More

Your business structure is one of the most powerful tools you have to control your tax liability. By understanding how each type affects your bottom line and making informed decisions, you can keep more money in your business and avoid unnecessary tax stress.

Whether you’re just starting out or ready to restructure, now is the time to evaluate your setup and take action. A smarter structure means less tax—and more resources to grow your vision.

Would you like a free tax structure comparison worksheet or a guide to switching from LLC to S Corp?

How to Save Money on Taxes by Structuring Your Small Business Correctly