Business · Illinois
Choosing a Business Entity in Illinois: LLC, S Corp or C Corp, Decided With the Tax Math
Business entity selection is two decisions wearing one name: what shields you from the business's liabilities, and how its profit is taxed. This page separates them, puts the Illinois figures beside the federal ones, and shows where each form fits.
Firm particulars
- Attorney
- Hani H. Khatib, Attorney at Law · CPA · LL.M. (Taxation)
- Office
- 6600 W College Dr, Ste 207, Palos Heights, IL 60463
- Hours
- Monday to Friday, 9:00 a.m. to 5:00 p.m.
- Telephone
- (708) 722-2222
- info@khatiblaw.com
- Accreditation
- BBB Accredited since April 2022 · A+
Start here
Is this you?
You are about to form a business and have heard "just do an S corp" from one friend and "always an LLC" from another.
You have run the business as a sole proprietor for years and a customer's slip-and-fall claim has made the exposure real.
Two of you are going into business together and have not decided whether that makes you partners, members or shareholders.
An investor has offered money on the condition that the company is a corporation, and you want to know what that costs you in Illinois tax.
You own three rental buildings in your own name and want them in some kind of entity before the next closing.
Business entity selection is easier when you separate the legal question from the tax question. The legal question is which form shields your personal assets from the business's debts and judgments, how the owners govern it, and how an interest can be transferred. The tax question is how the profit is taxed — on your own return as self-employment income, through a partnership, through an S corporation where only salary carries payroll tax, or in a C corporation with its own rate and a second tax on dividends. Illinois adds its own layer to the tax question, because the state's personal property replacement tax applies to partnerships, S corporations and C corporations at different rates and not at all to a sole proprietor.
The table sets the common choices beside each other. The sections that follow explain the rows that matter most to owners in Cook County and the southwest suburbs. Choosing the entity is one part of the firm's work for small companies, described on the business attorney hub.
| Sole proprietorship | General partnership | LLC (default tax) | LLC or corporation with S election | C corporation | |
|---|---|---|---|---|---|
| Owner liability for business debts | Unlimited | Unlimited, each partner | Protected (805 ILCS 180/10-10) | Protected | Protected |
| Federal income tax | Owner's return, Schedule C | Form 1065, passes to partners | Disregarded (one owner) or partnership (two or more) | Form 1120-S, passes to shareholders | 21% at the corporation; dividends taxed again |
| Self-employment or payroll tax | 15.3% on net profit | 15.3% on each partner's share | Same as sole proprietor or partnership | Payroll tax on owner salary only; distributions exempt | Payroll tax on owner salary; dividends exempt |
| Illinois tax | 4.95% on the owner | 1.5% replacement tax at the entity plus 4.95% on partners | None at the entity (one owner); 1.5% replacement tax (two or more) | 1.5% replacement tax plus 4.95% on shareholders | 7% income tax plus 2.5% replacement tax |
| Illinois Secretary of State fees | None (Cook County assumed name $50 if trading under a name) | None (LLP registration $100 per partner if elected) | $150 to form; $75 annual report | Same as the underlying entity | $150 to incorporate (the initial franchise tax is covered by the $10,000 exemption for most small corporations); $75 annual report plus any franchise tax above the exemption |
| Required formalities | None | Partnership agreement advisable | Operating agreement advisable; annual report | Operating/shareholder agreement; annual report; payroll | Bylaws, annual shareholder meeting, minutes, annual report |
| Who may own it | One person | Two or more | Anyone | Up to 100 eligible shareholders; one class of stock | Anyone; multiple classes |
A sole proprietorship is you, doing business. There is nothing to file with the Secretary of State; if you trade under another name you register it with the Cook County Clerk for $50 and publish notice. Income goes on Schedule C and all of it carries self-employment tax, and every business debt, lease and judgment is yours personally. The form suits a very small, low-risk, no-employee activity and almost nothing else; the trigger to form an entity is usually the first lease, employee, significant contract or partner.
Under the Uniform Partnership Act, two or more persons carrying on a business for profit as co-owners form a partnership whether or not they intend it (805 ILCS 206/202). Two friends who open a shop together and split the profits are partners, and each is personally liable for the partnership's debts, including the other's business-related negligence. A multi-member LLC gives the same partnership tax treatment with a liability shield for each member, so for any operating business the LLC is the better form; the general partnership survives mainly by accident.
The Illinois LLC is the starting point for most owner-operated businesses because it does the most with the least. Members are not personally liable for the company's obligations, and the Act states that failure to observe internal formalities is not by itself a ground for personal liability. Tax treatment is a choice: disregarded or partnership by default, S corporation or C corporation by election. The costs are $150 to form and $75 a year, and the step-by-step guide shows the procedure. One correction to a common claim: a multi-member LLC taxed as a partnership does pay Illinois tax at the entity level, the 1.5 percent replacement tax, even though its federal income passes through.
"S corp vs LLC" compares a tax status with an entity, which is why the comparison confuses people. An Illinois LLC can be an S corporation. What changes with the election is not the liability shield or the operating agreement; it is the tax return and the owner's pay. Under the default, every dollar of a working owner's profit carries 15.3 percent self-employment tax up to the Social Security wage base and 2.9 percent above it. Under the S election, the owner draws a reasonable salary through payroll, which carries the same tax, and takes the remaining profit as a distribution, which does not. The saving is the payroll tax on the distribution; the cost is payroll administration, a separate corporate return, the 1.5 percent Illinois replacement tax, and the discipline of a defensible salary. The S-corp election page has the deadline, the reasonable-compensation rule and an illustrative break-even table.
The C corporation pays its own federal tax at a flat 21 percent and Illinois tax at 9.5 percent (7 percent income tax plus 2.5 percent replacement tax), and its shareholders pay tax again on dividends. For an owner who takes the profit out each year that double layer is expensive. Three situations change the answer:
- Outside investors. Venture and angel investors generally require a corporation with preferred stock, which neither an LLC taxed as a partnership nor an S corporation can offer in the same way.
- Retained earnings. A business that reinvests profit rather than distributing it may pay less at 21 percent than its owners would at individual rates, deferring the second layer until dividends are paid or the stock is sold.
- Qualified small business stock. Section 1202 of the Internal Revenue Code lets a non-corporate shareholder exclude gain on the sale of stock in a domestic C corporation acquired at original issue. For stock issued after July 4, 2025, the exclusion is 50 percent after three years, 75 percent after four and 100 percent after five, capped at $15 million per issuer (indexed from 2027) or ten times the shareholder's basis, and the corporation's gross assets must not exceed $75 million. Stock issued on or before that date keeps the prior rules: a five-year holding period and a $10 million cap. For a founder who expects to sell the company, this exclusion can outweigh years of double taxation.
A C corporation also offers fringe benefits to owner-employees that an S corporation cannot, and no limit on the number or type of shareholders. It carries the heaviest formalities under the Business Corporation Act: bylaws, an annual shareholder meeting, minutes, a stock ledger, and a franchise tax with the annual report, though the first $10,000 of franchise tax liability is now exempt.
The federal comparison is well known; the Illinois layer is where owners get surprised. A sole proprietor or single-member LLC owner pays 4.95 percent on the net profit and nothing at the entity level; a partnership or multi-member LLC pays the 1.5 percent replacement tax at the entity level and the partners 4.95 percent on their shares; an S corporation pays the same 1.5 percent and its shareholders 4.95 percent; a C corporation pays 7 percent income tax plus 2.5 percent replacement tax, and its Illinois-resident shareholders 4.95 percent on dividends. Partnerships and S corporations may elect, year by year, to pay the 4.95 percent pass-through entity tax at the entity level with a matching credit to the owners; whether that helps depends on the owners' federal deductions and is part of tax planning.
An LLC separates a building's liabilities from the owner's other assets; a series LLC does the same for several buildings in one $400 filing, provided the Articles give notice of the series, each series files a $50 certificate of designation and separate records are kept (805 ILCS 180/37-40); an Illinois land trust keeps the owner's name out of the public record and lets the beneficial interest be assigned without a deed, but gives no liability protection. Many investors use a land trust for title and an LLC as the beneficiary. The land trust vs LLC article works through the due-on-sale clause, the homeowner exemption and the tax side for a rental, and the real estate attorney pages cover the transfer itself.
The tax classification of an LLC can be changed without touching the entity: Form 2553 for S status, Form 8832 for C status, each with timing limits and a waiting period before the next change. Changing the legal form is done under the Illinois Entity Omnibus Act (805 ILCS 415): a plan of conversion approved by the owners and a statement of conversion filed with the Secretary of State ($100) turns a corporation into an LLC or an LLC into a corporation without forming a new entity. Whether the EIN survives depends on the tax classification before and after: the IRS requires a partnership that incorporates to obtain a new EIN, while a change of tax election alone does not. The tax consequences depend on direction. Moving an LLC or partnership into a corporation is generally tax-free. Moving a corporation into an LLC taxed as a partnership is treated as a liquidation of the corporation, which can trigger tax on appreciated assets and goodwill at the corporate and shareholder levels. That asymmetry is the main reason to get the first choice right.
- Liability. What does the business do that could produce a claim, and what personal assets are exposed if it does? The answer rules out the sole proprietorship and general partnership for most operating businesses.
- Profit and pay. Will the business earn well above a reasonable salary for your work? That is the S-election question.
- Owners. Who owns it now, who might later, and are they all eligible S-corporation shareholders? Entities, non-resident aliens and investors wanting preferred stock point away from S status.
- Capital. Will you raise money from outsiders, and will they require a corporation?
- Exit. Do you expect to sell, hand the business to family, or wind it down? The C corporation's qualified small business stock exclusion and the succession-planning tools favor different forms.
The difference
Why an attorney who is also a CPA
The Illinois replacement tax is on the page
An entity comparison that stops at the federal rules misses 1.5 percent, 2.5 percent and the pass-through entity election.
The exit is modeled at the start
Whether a future sale will be a stock deal or an asset deal, and whether qualified small business stock is achievable, is decided by today's choice.
One engagement
Entity choice, formation documents and the tax election are drafted together. The advice is privileged; the filed Articles and the election form are not.
Process
How it works
Intake
Week one · about 30 minutes · by phone
Owners, the business, expected profit, property, licenses, investors and the likely exit.
Written comparison
Usually within a week of the call
The two or three realistic options with the federal and Illinois figures for your numbers, and a recommendation.
Formation or conversion
Usually weeks two to four · tax elections within their own deadlines
Filing with the Secretary of State, the owners' agreement, the EIN, and any tax election within its deadline. See the business formation page.
Review at year one
About twelve months later · a short call
A check once the first year's numbers are in, to confirm the tax classification still fits.
Questions
Questions we are asked
LLC or S corp — which is better for a small business?
The question compares an entity with a tax status, and the usual answer is both: form an Illinois LLC for its flexibility and light formalities, and elect S-corp tax treatment on Form 2553 only if the profit above a reasonable owner salary is large enough to justify payroll, a separate return and the Illinois 1.5 percent replacement tax. A business with modest profit, rental real estate, or owners who are not eligible S shareholders should stay with the LLC's default tax treatment. The S-corp election page has an illustrative break-even.
What is the difference between an LLC and an S corporation?
An LLC is a legal entity created under the Illinois Limited Liability Company Act; it provides liability protection and can be taxed four different ways. An S corporation is a federal tax classification that either a corporation or an LLC can elect. So an "S corp" might be a corporation formed under the Business Corporation Act or an LLC that filed Form 2553. The entity choice decides formalities, governance and how ownership transfers; the tax choice decides whether the owner's profit above salary carries self-employment tax.
When should a sole proprietor switch to an LLC?
When the business has anything to lose that is not already insured, when it signs contracts or leases, when it hires, or when it takes on a second owner. A sole proprietor is personally liable for every business debt and judgment; an LLC member is not liable solely by reason of membership. The Illinois cost of the switch is the $150 filing fee and $75 a year, plus an operating agreement; the federal tax treatment of a single-member LLC is identical to a sole proprietorship until you elect otherwise, so the switch does not change your return.
When does a C corporation make sense?
Three situations. First, when outside investors will require it: venture and angel investors typically want a corporation with preferred stock. Second, when the business will retain earnings rather than distribute them, because the flat 21 percent federal corporate rate can be lower than the owners' individual rates — though Illinois adds 9.5 percent and dividends are taxed again. Third, when the qualified small business stock exclusion is realistic: for stock issued after July 4, 2025, gain is 50 percent excluded after three years, 75 percent after four and 100 percent after five, up to $15 million per issuer, for C corporations with gross assets up to $75 million.
How are LLC members taxed in Illinois?
A single-member LLC's income is reported on the owner's Illinois return at 4.95 percent. A multi-member LLC taxed as a partnership files Form IL-1065 and pays the personal property replacement tax at 1.5 percent of net income at the entity level; each member then pays 4.95 percent on his or her share. An LLC taxed as an S corporation files IL-1120-ST and pays the same 1.5 percent. An LLC taxed as a C corporation files IL-1120 and pays 7 percent income tax plus 2.5 percent replacement tax. Partnerships and S corporations may also elect the 4.95 percent pass-through entity tax.
Partnership or multi-member LLC?
A general partnership forms automatically when two or more people run a business for profit together, and every partner is personally liable for partnership debts. A multi-member LLC is taxed exactly the same way by default — as a partnership — but its members are not personally liable for the company's obligations. For almost any operating business the LLC is the better form for the same tax result. A registered limited liability partnership is the alternative for professional practices that want to keep the partnership form.
Can I change my entity type later?
Yes, with planning. An LLC can change its federal tax classification without changing its entity: Form 2553 for S status, Form 8832 for C status, each with timing limits. Changing the legal entity — a corporation to an LLC, or an LLC to a corporation — can be done by a statement of conversion under the Illinois Entity Omnibus Act (805 ILCS 415), filed with the Secretary of State for $100. The tax consequences differ sharply by direction: converting an LLC into a corporation is usually tax-free; converting a corporation into an LLC taxed as a partnership is treated as a liquidation and can trigger tax on appreciated assets.
Which entity should hold a rental property — LLC, series LLC or land trust?
An LLC gives liability protection, a series LLC puts each property in its own liability cell under one filing, and an Illinois land trust gives privacy and easy transfer of the beneficial interest but no liability shield, which is why many investors hold title in a land trust with an LLC as beneficiary. The number of properties, the lender's due-on-sale clause and how the income is taxed decide the structure; the land trust vs LLC article works through a rental example.
Related
Related services
Formation
Do I need a lawyer to form an LLC in Illinois?
A business formation lawyer who is also a CPA: filing the articles takes twenty minutes, but deciding what to file, how the profit will be taxed and what the owners have agreed to is the part that lasts. Khatib Law LLC does both, from one office in Palos Heights.
LLCs, corporations and partnershipsS-corp election
What is an S-corp election and who should make it?
An S-corp election can cut an owner's self-employment tax, or it can add payroll, a second return and Illinois replacement tax for no net saving. The difference is arithmetic, and the deadline is short. Khatib Law LLC runs the numbers and files the form.
Form 2553, deadline and salary ruleHow to get an LLC in Illinois
How much does it cost to start an LLC in Illinois?
To start an LLC in Illinois you choose a name that ends in LLC, appoint an Illinois registered agent, file Articles of Organization (Form LLC-5.5) with the Secretary of State for $150, get a free EIN, sign an operating agreement, settle the tax treatment and register with the Illinois Department of Revenue.
Name, agent, Articles, EIN, taxes
Your attorney
Hani H. Khatib
Attorney at Law · CPA · LL.M. (Taxation)
Founder and managing attorney of Khatib Law LLC, established in Palos Heights in 2017. An attorney licensed in Illinois and a Certified Public Accountant, he concentrates his practice in estate planning, real estate, tax controversy and small-business matters. About Hani Khatib
Request a consultation
Tell us what you are facing.
A sentence or two is enough to start. We will tell you what the first meeting involves, and whether there is a charge for it, before you commit to anything.
(708) 722-2222
Monday to Friday, 9:00 a.m. to 5:00 p.m. · 6600 W College Dr, Ste 207, Palos Heights
What happens next
Your message goes to the firm’s office, not a call centre.
If you mention a deadline, it is read first.
We run a conflicts check and, if we can help, call or email you to set a time.
We confirm the kind of matter and what the first meeting involves, including whether there is a charge for it.
If we go forward, you receive a written engagement letter.
Scope and fee basis in writing before any work begins. Please do not email documents until we have confirmed an engagement in writing.
What to bring to the first meeting
- A rough profit estimate for the first two years.
- The owners' names and percentages, and who will run the business day to day.
- Whether real estate, a professional license or an outside investor is involved.
- How you expect to leave the business one day: a sale, the family, or a wind-down.