S corporation, LLC or sole proprietor: how the choices differ in Texas

This guide is general information. It does not tell you which structure to pick. The choice depends on your income, your partners, your plans and your state and federal facts. Details were checked against IRS and Texas Comptroller pages on October 21, 2026. Forms and rules change, so check the year you file.

What are the three common choices?

Most Texas small business owners pick from three: a sole proprietorship, a limited liability company (LLC), or an S corporation. The first two describe how the business is set up. The third describes how the IRS taxes a corporation.

That difference trips up many owners. “LLC” is a legal structure created by filing with the state. “S corporation” is a federal tax status. An LLC can elect S corporation tax treatment. A corporation can too. The table shows the usual path for each.

The sections below explain each row. If you are not formed yet, the guide on starting a business in Texas lists the formation steps.

How is a sole proprietorship taxed?

A sole proprietor reports business income and expenses on Schedule C with the personal Form 1040. The IRS defines the term this way: “A sole proprietor is someone who owns an unincorporated business by themselves.” There is no separate business income tax return.

Net profit is subject to income tax and also to self-employment tax. The IRS explains that “Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves.” The glossary entry on self-employment tax gives the plain definition. A sole proprietor also pays estimated tax during the year.

A sole proprietorship gives no legal wall between you and the business. Debts and claims can reach your personal assets. An attorney can explain that risk. A CPA looks at the tax side only.

How is an LLC taxed?

An LLC has no one tax treatment. The IRS treats it based on its owners and its elections. The IRS sole proprietor page says that if you are the sole member of a domestic LLC and elect to treat it as a corporation, you are not a sole proprietor. A single owner LLC that makes no election is generally treated as a sole proprietorship for federal income tax.

A multi-owner LLC is generally taxed as a partnership unless it elects otherwise. It files Form 1065 and gives each owner a K-1. The LLC glossary entry explains the legal form in plain words.

In Texas, an LLC is a taxable entity for the franchise tax, including a single member LLC. The Comptroller lists sole proprietorships as outside the tax, “except for single member LLCs.” So forming a one-person LLC creates a franchise tax report that a sole proprietor would not file. The tax may still be zero. Read the Texas franchise tax guide for the threshold and the filing.

How is an S corporation taxed?

An S corporation passes its income through to its owners. The IRS says S corporations “elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.” The corporation files Form 1120-S, and each shareholder gets a K-1. Shareholders report the amounts on their own returns.

An S corporation is a tax election, not a different kind of company. To make the election, “the corporation must submit Form 2553, Election by a Small Business Corporation signed by all the shareholders.” The IRS 2026 calendar lists the date to file Form 2553 for an election that starts with calendar year 2026. Timing rules are strict, so check the Form 2553 instructions or ask a CPA before you file.

Not every business can be an S corporation. The IRS sets limits on the number and type of shareholders and on stock classes. Those limits are listed on the IRS S corporation page. An S corporation also adds cost: a separate return, payroll, and a Texas franchise tax report.

What is reasonable compensation?

It is the pay an S corporation owner who works in the business must take as wages. The IRS says S corporations “must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee.”

The reason is employment tax. Wages carry Social Security and Medicare tax. Distributions do not. The IRS can reclassify payments to a shareholder as wages. So an owner cannot take all the profit as a distribution and no salary. The IRS looks at what the owner does for the company and where its income comes from.

The glossary explains reasonable compensation. Our post on S corporation reasonable salary goes further. No formula gives the right number. A CPA looks at your role, hours, duties and market pay.

How do payroll and self-employment tax change?

A sole proprietor pays self-employment tax on net profit. An S corporation owner pays payroll tax on wages instead. The payroll runs through the company, with Form 941 each quarter and a Form W-2 for the owner.

That sounds like a way to cut tax, and sometimes the total is lower. It also adds payroll cost, a separate tax return, and a Texas franchise tax report. For a small profit, the added cost can cancel any saving. For a larger profit, the picture may change. Ask a CPA to model both with your own numbers. A model should include the extra preparation cost.

What does the Texas franchise tax change?

It adds a report for every LLC and corporation. Sole proprietors with no entity do not file. The Comptroller calls the tax “a privilege tax imposed on each taxable entity formed or organized in Texas or doing business in Texas.”

For most small businesses the tax due is zero, because revenue falls under the no tax due threshold. The report is still required. See the Texas business taxes guide for the full set of Texas taxes that follow an entity.

What should I ask a CPA before I choose?

Bring facts, not a guess. These questions help the first meeting.

1. What do I expect to earn this year and next?
2. Will I have partners or investors?
3. Will I pay myself, and how?
4. Will I hire employees or contractors?
5. What would a change of structure cost in forms and fees?
6. Which facts should I take to an attorney?

Wallace CPA, PLLC lists tax planning for business owners and tax preparation, including business returns, among its services. A CPA can compare the tax paths. An attorney handles the legal formation, the operating agreement and liability questions.

What are the costs of an S corporation?

Costs come in three kinds. The first is preparation: a separate business return, plus a K-1 for each owner. The second is payroll: setup, deposits, quarterly reports and year-end forms. The third is the Texas franchise tax report. None of these costs is fixed, so ask for a written scope before you decide. The tax saving, if any, has to beat all three.

Next step

To compare these choices with your own numbers, read about tax planning, call Wallace CPA, PLLC at (877) 682-1171, or use the contact form. This guide is general information. Talk to a CPA about your own situation before you form an entity or file an election.