S-Corp vs Partnership: Complete Tax Comparison for 2026

Both S-Corporations and partnerships are pass-through entities. Neither pays federal income tax at the entity level. Income flows through to the owners’ personal returns.

But the similarities end there. How that income gets taxed, how owners can split profits, who can own the business, and how losses work—these differ substantially between the two structures.

This guide compares S-Corps and partnerships across every tax dimension that matters. By the end, you’ll know which structure makes sense for your situation.

Key Takeaways

• S-Corps save on self-employment tax for active owners with net income above $60K-$80K
• Partnerships offer flexible profit allocations—S-Corps require strict pro-rata distributions
• Partnership debt increases your basis; S-Corp debt does not (critical for loss deductions)
• S-Corps have ownership restrictions (100 US shareholders max, no foreign or entity owners)
• Neither is universally better—the right choice depends on your specific situation

Pass-Through Taxation: The Common Ground

Before diving into differences, let’s establish what S-Corps and partnerships share.

Both are pass-through entities:

• No federal income tax at the entity level
• Income reported on owners’ personal returns via Schedule K-1
• Both eligible for the 20% QBI deduction (now permanent under OBBBA)
• Business losses can offset other personal income (subject to basis limits)

K-1 Reporting

Both structures issue Schedule K-1s to owners annually. The K-1 reports each owner’s share of income, deductions, credits, and other tax items. This information flows to the owner’s Form 1040.

QBI Treatment

Since July 2025, the 20% QBI deduction is permanent for both entity types. The same income thresholds and limitations apply: $203,000 for single filers, $406,000 for married filing jointly in 2026.

The differences begin when you look at how income gets taxed on the way to that K-1.

For detailed partnership taxation rules, see our Complete Guide to Partnership Taxation.

Self-Employment Tax: The Key Difference

This is where most people start, and for good reason. Self-employment tax is often the deciding factor.

Partnerships

General partners pay 15.3% self-employment tax on their distributive share of partnership income. This applies to all net self-employment income, not just what they withdraw.

Limited partners have more favorable treatment—they generally avoid SE tax on their partnership share, except for guaranteed payments for services.

S-Corporations

S-Corp shareholders who work in the business pay themselves a W-2 salary. That salary is subject to FICA taxes: 6.2% Social Security plus 1.45% Medicare from both the employee and employer (15.3% total).

The remaining profit, taken as distributions, is not subject to employment taxes.

The Math

Here’s where it gets interesting. Say your business generates $200,000 in net income and you work full-time in the business.

As a General Partner:

• Self-employment tax: $200,000 × 15.3% = $30,600

As an S-Corp with $80,000 Salary:

• FICA on salary: $80,000 × 15.3% = $12,240
• FICA on $120,000 distributions: $0
• Total employment taxes: $12,240

Annual savings: $18,360

That’s real money. At higher income levels, the savings grow, though they cap once salary exceeds the Social Security wage base ($184,500 in 2026).

The Reasonable Salary Requirement

This advantage comes with strings attached. The IRS requires S-Corp owner-employees to pay themselves reasonable compensation—what you’d pay an unrelated person to do the same job in the same location. Pay yourself too little, and the IRS can reclassify distributions as wages and assess back taxes, penalties, and interest.

For detailed guidance on SE tax in partnerships, see our Partnership Self-Employment Tax Guide.

Flexibility in Profit Allocation

Partnerships win decisively on flexibility.

Partnership Allocations

Partners can agree to split profits and losses in almost any proportion they choose, as long as the allocations have “substantial economic effect.” This means:

• A 30% owner can receive 50% of the profits
• Losses can be allocated to partners who can best use them
• Different income types (ordinary income, capital gains) can be allocated differently
• Allocations can change year to year

This flexibility is powerful for businesses with partners who contribute differently—one provides capital, another provides expertise—or who have different tax situations.

S-Corp Restrictions

S-Corporations require strict pro-rata distribution. If you own 40% of the shares, you receive 40% of the income. No exceptions.

This rule is embedded in the “one class of stock” requirement for S-Corp status. Any deviation could terminate your S election.

Why This Matters

Consider two business partners: one high-income, one in a lower bracket. In a partnership, they could allocate losses to the partner who benefits most. In an S-Corp, each gets their proportional share regardless of who could use it.

For more on partnership profit mechanics, see Guaranteed Payments to Partners Guide.

Ownership Restrictions

S-Corps have significant limitations on who can be an owner. Partnerships have virtually none.

Why These Restrictions Exist

S-Corp status is an IRS election under Subchapter S of the tax code. It’s a special privilege that comes with rules. Violate any rule—even inadvertently—and you can lose S-Corp status retroactively.

Practical Implications

Planning to bring in investors? If any potential investor is a foreign national, another corporation, or certain types of trust, S-Corp is off the table.

Growing beyond 100 owners? S-Corp won’t work.

Want multiple classes of stock with different rights? Not in an S-Corp.

Partnerships have none of these constraints.

Formation and Ongoing Compliance

The practical burden of running each structure differs.

Forming a Partnership

Multi-member LLCs are partnerships by default for tax purposes. No election required. You form the LLC with your state, and the IRS automatically treats it as a partnership.

You’ll need:

• Articles of organization (state filing)
• Operating agreement (internal document)
• EIN from the IRS

Forming an S-Corp

S-Corp status requires an IRS election. You can either:

1. Form a corporation and file Form 2553 to elect S status, or
2. Form an LLC and file Form 2553 to be taxed as an S-Corp

The Form 2553 must be filed within 75 days of formation (or by March 15 for existing entities wanting the election effective January 1).

Ongoing Requirements

S-Corps require payroll. You must run yourself through payroll, withhold taxes, file quarterly payroll returns, and issue W-2s. This adds administrative burden and cost.

Partnership K-1s are more complex, with more boxes, more schedules, and more special allocations to track. But there’s no payroll requirement for partners.

For guidance on S-Corp formation, see How to Start an S-Corp.

Basis Rules and Loss Deductions

This technical difference matters enormously for certain businesses.

The Basic Rule

You can only deduct losses up to your basis in the entity. Losses exceeding basis are suspended and carried forward until you have sufficient basis.

Partnership Basis: Debt Counts

In a partnership, your basis includes your share of partnership debt. If the partnership borrows $500,000 to buy equipment, and you’re a 50% partner, your basis increases by $250,000.

This is huge for real estate partnerships that use significant debt financing. It means you can deduct depreciation losses even when you haven’t contributed that much cash.

S-Corp Basis: Only Direct Loans

In an S-Corp, corporate debt doesn’t increase your basis. Only direct loans from you to the corporation add to your basis.

If your S-Corp borrows $500,000 from a bank, your basis is unaffected. You get no additional loss deduction capacity from that debt.

Example

Both entities generate $100,000 in losses. You’ve contributed $20,000 in cash.

Partnership (with your share of $100,000 in entity debt):

• Your basis: $20,000 (cash) + $100,000 (debt share) = $120,000
• Deductible loss: $100,000 (full amount)

S-Corp (corporate debt doesn’t count):

• Your basis: $20,000 (cash only)
• Deductible loss: $20,000
• Suspended loss: $80,000

This is why real estate investors and loss-generating businesses often prefer partnerships.

For detailed basis calculations, see Partner Basis Calculation Guide.

Property Contributions and Distributions

How property moves in and out of the entity differs significantly.

Contributing Property

Partnerships: Contributing appreciated property is generally tax-free. If you contribute land worth $200,000 with a $50,000 basis, no gain is recognized at contribution. The partnership takes your $50,000 basis (a carryover basis), and special allocation rules eventually tax the built-in gain to you.

S-Corps: Contributing appreciated property can trigger gain. While Section 351 provides tax-free treatment for corporate formations, the rules are stricter. If the contribution doesn’t qualify, you recognize gain immediately.

Distributing Property

Partnerships: Generally more flexible. Non-liquidating distributions of property are typically tax-free up to your basis.

S-Corps: Distributions of appreciated property trigger corporate-level gain, which flows through to shareholders. Even though S-Corps don’t pay entity tax, the gain is recognized and passed to you on your K-1.

When This Matters

Planning to contribute real estate or other appreciated assets? Partnership treatment is more favorable.

Expecting to distribute property (rather than cash) to owners? Partnerships are more flexible.

State Tax Considerations

State treatment adds another layer of complexity.

Entity-Level State Taxes

Some states impose entity-level taxes on S-Corps:

• California: 1.5% minimum franchise tax on net income
• New York: Fixed dollar amount based on receipts
• Illinois: 1.5% replacement tax

Partnerships generally face lower or no entity-level state taxes (though some states do impose fees or taxes on partnerships).

Pass-Through Entity Tax (PTET)

The good news: 36 states now offer PTET elections for both S-Corps and partnerships. These elections work around the federal SALT cap by shifting state income tax to the entity level, where it’s fully deductible.

Multi-State Operations

If your business operates in multiple states, both structures create filing obligations in each state. However, partnership apportionment rules can be more complex due to the flexibility in allocations.

For Texas-specific considerations, see Texas CPA Firm.

Side-by-Side Comparison Chart

When to Choose S-Corp

S-Corp election makes sense when:

You’re a single owner or have few shareholders. The ownership restrictions aren’t a problem, and the administrative burden is manageable.

Net income consistently exceeds $60,000-$80,000. Below this threshold, the SE tax savings may not justify the additional complexity and compliance costs.

You actively work in the business. The reasonable salary requirement means you’re already paying yourself. The question is just how to characterize it.

Simple profit-sharing works. If all owners are comfortable with pro-rata distributions matching their ownership percentages, S-Corp restrictions aren’t limiting.

SE tax savings is your priority. If minimizing self-employment tax is your primary goal, S-Corp typically delivers.

For a detailed comparison with LLCs, see LLC vs S-Corp Complete Comparison.

When to Choose Partnership

Partnership structure makes sense when:

Multiple owners with varying contributions. One partner contributes capital, another contributes expertise, another contributes a client list. Partnerships can compensate these differently.

You need flexible profit allocations. Partners have different tax situations, or contributions justify non-proportional distributions.

Significant debt financing is planned. If the business will borrow substantially, partnership basis rules let you deduct losses against that debt.

Foreign investors or entity partners are involved. S-Corp ownership restrictions would disqualify these owners.

Real estate is the business. Real estate partnerships benefit from debt basis, depreciation allocations, and tax-free property contributions.

You’re planning to raise outside capital. Venture capital and private equity investors typically cannot hold S-Corp stock.

For partnership-specific services, see Partnership Tax Services.

Can You Convert Between Structures?

Circumstances change. What if you chose wrong, or your situation evolved?

Partnership to S-Corp

This is possible but requires careful planning:

• The partnership can convert to a corporation and elect S status
• Or an LLC can revoke partnership treatment and elect S-Corp taxation
• Tax consequences depend on the method and timing
• Built-in gains may be triggered

Timing matters. The election must be filed within 75 days of the desired effective date, or by March 15 for calendar-year entities.

S-Corp to Partnership

This is generally cleaner:

• Revoke the S election
• If underlying entity is an LLC, it automatically becomes a partnership for tax purposes
• If a corporation, liquidate into an LLC
• Usually accomplishable without significant tax cost

Before Converting

Analyze the full tax impact before making any change. Consider:

• Built-in gains in appreciated assets
• Timing of the change
• State tax implications
• Administrative transition costs

For conversion guidance, see Converting LLC to S-Corp Guide.

Frequently Asked Questions

Is an S-Corp or partnership better for taxes?

Neither is universally better. S-Corps typically save on self-employment tax for active owners with net income above $60,000-$80,000. Partnerships offer more flexibility in allocations and better treatment for debt-financed losses. The right choice depends on your specific situation.

Do S-Corps pay less self-employment tax than partnerships?

Yes, in most cases. General partners pay 15.3% SE tax on their entire share of partnership income. S-Corp owners only pay FICA on their W-2 salary; distributions are not subject to employment taxes.

Can a partnership elect S-Corp status?

An LLC taxed as a partnership can elect S-Corp taxation by filing Form 2553. The underlying LLC doesn’t change; only the tax treatment changes. A general partnership would need to convert to an LLC or corporation first.

What’s the main advantage of S-Corp over partnership?

Self-employment tax savings. By paying a reasonable salary and taking the rest as distributions, S-Corp owners avoid 15.3% SE tax on the distribution portion.

Which is easier to manage?

Partnerships are generally simpler at formation (default tax treatment, no IRS election). S-Corps are simpler ongoing in some ways (simpler K-1s) but require payroll administration, which partnerships don’t.

Can I switch from partnership to S-Corp?

Yes. An LLC currently taxed as a partnership can file Form 2553 to elect S-Corp taxation. This must be done within 75 days of the desired effective date or by March 15 for the current year. Analyze the tax consequences before converting.

Making the Right Choice

The S-Corp vs. partnership decision isn’t about finding the “better” structure. It’s about matching the structure to your situation.

Consider:

• Who will own the business (now and in the future)?
• How will profits be split?
• Will you use significant debt financing?
• How important is SE tax savings vs. flexibility?
• What’s your tolerance for administrative complexity?

The right answer depends on these factors, not on which structure is “better” in the abstract.

If you’re evaluating entity structure for a new business or reconsidering your current setup, schedule an entity structure analysis. We specialize in both S-Corp and partnership taxation and can help you make the choice that fits your specific goals.

For S-Corp services, see S-Corp Tax Services. For partnership services, see Partnership Tax Services.