Partnership vs S-Corp: Which Business Structure Saves More on Taxes?

Partnership or S-Corp? The answer determines how much you pay in self-employment tax, how you can split profits, and how much flexibility you have with business debt.

Both are pass-through entities. Neither pays federal income tax at the entity level. But the similarities end there. The structure you choose affects your tax bill every year you’re in business.

Key Takeaways: Partnership vs S-Corp

• S-Corps save self-employment tax on distributions above reasonable salary (15.3% savings on that portion)
• Partnerships include debt in partner basis; S-Corps do not—critical for leveraged businesses
• Partnerships allow flexible profit allocations; S-Corps require strictly pro-rata distributions
• S-Corps limit owners to 100 U.S. individuals; partnerships allow unlimited owners of any type
• Profitable service businesses often benefit from S-Corp; debt-heavy businesses favor partnership

This comparison breaks down the differences that actually matter: self-employment tax treatment, basis rules for debt, profit allocation flexibility, and when each structure makes sense.

How Partnerships and S-Corps Are Similar

Before diving into differences, understand what these structures share.

Pass-Through Taxation

Both partnerships and S-Corps are pass-through entities. The business itself doesn’t pay federal income tax. Instead, profits and losses flow through to owners, who report them on personal returns.

This avoids double taxation. C-Corps pay corporate tax on profits, then shareholders pay again when dividends are distributed. Pass-throughs pay once, at the owner level.

QBI Deduction Eligibility

Both partnerships and S-Corps qualify for the Section 199A qualified business income deduction. Owners can deduct up to 20% of qualified business income, subject to limitations based on income, W-2 wages, and property basis.

Multiple Owners Allowed

Both structures accommodate multiple owners. Partnerships have partners. S-Corps have shareholders. Neither is limited to a single owner, though S-Corps cap shareholders at 100.

Liability Protection

When properly structured, both offer liability protection. An LLC taxed as a partnership protects members from business debts. An S-Corp protects shareholders similarly. The liability protection comes from the legal entity, not the tax classification.

For a complete overview of how partnership taxation works, see our partnership taxation guide.

The Critical Differences: A Side-by-Side Comparison

For details on S-Corp rules, see our S-Corporation tax guide.

Self-Employment Tax: The Biggest Difference

This is where most of the tax savings conversation starts.

Partnership Treatment

General partners pay self-employment tax on their entire share of partnership ordinary income. The rate is 15.3% (12.4% Social Security + 2.9% Medicare), with the Social Security portion capping at $168,600 of earnings for 2024.

If your partnership earns $200,000 in profit and you’re a 50% general partner, you pay self-employment tax on $100,000. That’s roughly $14,130 before any deductions.

Limited partners may avoid self-employment tax on their distributive share if they don’t participate in management. But the rules are murky, and the IRS has challenged this position.

S-Corp Treatment

S-Corp shareholders who work in the business must receive reasonable compensation as W-2 wages. Only those wages are subject to payroll taxes (equivalent to self-employment tax).

Profits distributed above the reasonable salary are not subject to payroll tax.

Same $200,000 profit scenario: If you’re a 50% S-Corp shareholder with a $60,000 reasonable salary, you pay payroll taxes on $60,000. The remaining $40,000 of your profit share passes through without additional payroll tax.

That’s approximately $9,180 in payroll tax instead of $14,130. A $4,950 savings per year.

The Reasonable Salary Requirement

S-Corp tax savings hinge on what constitutes reasonable compensation. The IRS doesn’t provide a formula, but factors include:

• Industry norms for the work performed
• Your experience and qualifications
• Hours worked
• Compensation paid to non-shareholders for similar work
• Overall business profitability

Set salary too low, and the IRS can reclassify distributions as wages, adding taxes plus penalties. The savings require compliance.

Basis and Debt: Why This Matters More Than You Think

This is the factor most comparisons overlook. And it’s critical for debt-financed businesses.

Partnership Basis Includes Debt

When a partnership borrows money, partners include their share of that debt in their basis. This applies to both recourse and non-recourse debt (with allocation rules varying by type).

Why does this matter? You can only deduct losses up to your basis. More basis means more loss deductions available.

Example: A partnership buys a $1 million property with $200,000 down and an $800,000 mortgage. A 50% partner’s initial basis includes $100,000 from their capital contribution plus $400,000 from their share of the mortgage. Total basis: $500,000.

If the property generates losses from depreciation and expenses, this partner can deduct up to $500,000 in losses (assuming other limitations don’t apply).

S-Corp Basis Excludes Entity Debt

S-Corp shareholders don’t get basis from entity-level debt. Their basis comes from:

• Stock basis (what they paid for shares plus retained earnings)
• Loan basis (only from direct loans the shareholder makes to the corporation)

Same Example as S-Corp: A 50% S-Corp shareholder who contributes $100,000 for stock has $100,000 basis. The company’s $800,000 mortgage doesn’t increase shareholder basis at all.

Losses exceeding $100,000 cannot be deducted currently. They’re suspended until the shareholder gets more basis.

This is why real estate investors often prefer partnerships. Leveraged properties generate paper losses from depreciation. Partnership structure lets owners use those losses.

For details on how basis works, see our partner basis calculation guide.

Profit Allocation Flexibility

Partnership: Special Allocations Allowed

Partnerships can allocate income, losses, and specific items (like depreciation or capital gains) differently than ownership percentages. These “special allocations” must have substantial economic effect under Section 704(b), but they offer planning flexibility.

Examples:

• Allocate more depreciation to partners who can use it
• Give preferred returns to capital investors before profits split to service partners
• Create waterfall structures where distributions change based on return thresholds

This flexibility matters for partnerships with partners contributing different things (capital vs. services) or partners in different tax situations.

Partnerships also use guaranteed payments to compensate partners for services or capital, separate from profit allocations.

S-Corp: Strictly Pro-Rata

S-Corp distributions must be proportional to stock ownership. If you own 50% of shares, you get 50% of distributions. No exceptions.

You can’t allocate more income to shareholders in lower brackets. You can’t give preferred returns to investors. Every shareholder gets their pro-rata share.

This simplicity can be a feature or a limitation depending on your situation.

When to Choose a Partnership

Partnership taxation typically makes more sense when:

You Have Significant Debt

If your business relies on financing, partnership basis rules let you deduct losses against your share of debt. Equipment-heavy businesses, real estate ventures, and leveraged acquisitions benefit.

You Need Flexible Profit Sharing

Multiple owners contributing different things (capital, services, expertise) often need allocations that don’t match ownership. Special allocations accommodate this.

You Have Non-Individual Owners

S-Corps can only have U.S. individuals, certain trusts, and estates as shareholders. Partnerships can have corporations, LLCs, partnerships, and foreign owners as partners. If your ownership structure includes entities, partnership is likely the only option.

You’re in the Start-Up Phase With Expected Losses

Early-stage businesses often generate losses. Partnership structure lets owners deduct those losses against other income (subject to basis and passive activity rules), especially if there’s debt involved.

When to Choose an S-Corp

S-Corp taxation typically makes more sense when:

Your Business Is Profitable and Cash-Flowing

Self-employment tax savings require distributable profits above reasonable salary. If you’re pulling out $75,000+ annually beyond what reasonable salary would be, S-Corp structure starts generating real savings.

Use our S-Corp tax calculator to estimate potential savings.

You Run a Service Business With Low Debt

Service businesses (consulting, professional services, agencies) often have minimal debt. The basis advantage of partnerships doesn’t apply. But self-employment tax adds up quickly on service income. S-Corp can save thousands annually.

Your Ownership Structure Is Simple

All U.S. individual owners, no need for special allocations, straightforward profit splits. S-Corp’s simpler structure works fine.

You Can Justify Reasonable Salary

The savings only work if your salary passes IRS scrutiny. If industry comparables support a salary significantly below your total profit, S-Corp makes sense. If your role commands a salary close to total profits anyway, the savings disappear.

Can You Convert Between Structures?

Partnership to S-Corp

This conversion is generally tax-free when done correctly. The partnership elects S-Corp status using Form 2553 (or elects LLC taxation, then elects S-Corp).

Timing matters. Elections filed by March 15 apply to the current tax year. Later elections apply to the following year (with some relief provisions).

See our converting LLC to S-Corp guide for the process.

S-Corp to Partnership

This direction is more complex. Revoking S status converts the entity to C-Corp taxation by default, not partnership. Converting to partnership may require restructuring the entity entirely.

The tax consequences can include gain recognition. Get professional guidance before unwinding an S-Corp election.

The LLC Advantage

LLCs can elect either partnership or S-Corp taxation without changing the legal entity. This flexibility makes LLCs the most common structure for small businesses. You form an LLC, then choose the tax treatment that makes sense for your situation.

Frequently Asked Questions

Which structure pays less in taxes: partnership or S-Corp?

It depends on your specific situation. S-Corps often save self-employment tax for profitable businesses with distributable income above reasonable salary. Partnerships offer better loss utilization for debt-heavy businesses. Calculate your numbers using our S-Corp calculator or work with a CPA to compare.

Can an S-Corp be a partner in a partnership?

Yes. S-Corps can be partners in a partnership. The S-Corp’s share of partnership income flows through to the S-Corp, then through to the S-Corp’s shareholders. However, partnerships cannot be shareholders of S-Corps.

Is an LLC a partnership or S-Corp?

An LLC is a legal entity that chooses its tax classification. Multi-member LLCs default to partnership taxation. Single-member LLCs default to disregarded entity (sole proprietor) taxation. Either can elect S-Corp status by filing Form 2553.

What is reasonable salary for an S-Corp owner?

There’s no fixed formula. Reasonable compensation considers industry norms, your experience and qualifications, hours worked, comparable salaries in your geographic area, and overall business profitability. The IRS requires owner-employees to receive reasonable compensation before taking distributions.

Do partnerships pay quarterly estimated taxes?

Partnerships don’t pay taxes directly. Partners are responsible for paying quarterly estimated taxes on their projected share of partnership income. The partnership provides estimated K-1 information to help partners calculate their liability.

Making the Right Choice for Your Business

The partnership vs. S-Corp decision comes down to four questions:

1. How much debt does your business carry? More debt favors partnership.
2. How much profit can you distribute above a reasonable salary? More profit favors S-Corp.
3. Do you need flexible profit allocations? Yes favors partnership.
4. What types of owners do you have? Entities or foreign owners require partnership.

Most businesses should run the numbers both ways. The “right” answer can change as your business evolves.

If you’d like help analyzing which structure fits your situation, we specialize in both partnership tax services and S-Corp tax services.

Schedule a structure analysis consultation