One of the most common questions we hear from self-employed individuals and small business owners is some version of: "Should I be an S-Corp?" It is a good question — and the answer can save you a meaningful amount of money. But it depends on your specific situation, and the wrong choice can cost you more than it saves.

Here is a clear breakdown of how LLCs and S-Corps are taxed, when an S-Corp election makes sense, and what to watch out for.

How an LLC Is Taxed by Default

A Limited Liability Company (LLC) is a legal structure, not a tax classification. By default, the IRS taxes a single-member LLC as a sole proprietorship and a multi-member LLC as a partnership.

In both cases, the business's net profit flows through to the owner's personal tax return. The owner pays:

1. Self-employment tax (15.3% on the first $168,600 of net profit in 2024, 2.9% above that) — this covers Social Security and Medicare
2. Federal income tax at ordinary income rates
3. State income tax (where applicable)

The self-employment tax is the key number to focus on. On $100,000 of net profit, that is approximately $14,130 in self-employment tax alone — before income tax.

How an S-Corporation Is Taxed

An S-Corporation is also a pass-through entity — profits flow to the owner's personal return and are taxed at ordinary income rates. The difference is in how self-employment taxes are handled.

In an S-Corp, the owner-employee must pay themselves a reasonable salary for the work they perform. That salary is subject to payroll taxes (the equivalent of self-employment tax, split between employer and employee). But profits distributed above and beyond the salary are not subject to payroll taxes.

Example:

• Business net profit: $150,000
• Reasonable salary: $80,000
• S-Corp distribution: $70,000
• Payroll taxes apply to: $80,000 (not $150,000)
• Estimated payroll tax savings: ~$10,710

That is real money — and it compounds every year.

When Does an S-Corp Election Make Sense?

The S-Corp election is not right for everyone. The savings only materialize when your net profit is high enough that the tax savings exceed the additional costs of running an S-Corp.

General rule of thumb: An S-Corp election typically makes financial sense when your net self-employment income is consistently above $40,000–$50,000 per year. Below that threshold, the administrative costs often outweigh the savings.

Costs of running an S-Corp include:

• Payroll processing (you must run actual payroll for yourself)
• Payroll tax filings (Form 941 quarterly, Form 940 annually, W-2 at year-end)
• S-Corp tax return (Form 1120-S) — typically more expensive to prepare than a Schedule C
• Potential state franchise taxes or minimum taxes (varies by state)
• More rigorous bookkeeping requirements

At higher income levels — $100,000+ in net profit — the savings are substantial and the costs are easily justified.

What Is a "Reasonable Salary"?

This is where many S-Corp owners get into trouble. The IRS requires that owner-employees pay themselves a reasonable salary for the services they provide to the business. If you set your salary artificially low to minimize payroll taxes, the IRS can reclassify distributions as wages — and assess back payroll taxes, penalties, and interest.

"Reasonable" means what you would pay someone else to do your job. Factors include:

• Industry compensation data for your role
• Your qualifications and experience
• The time you devote to the business
• The business's revenue and profitability

There is no single formula, but a salary that is conspicuously low relative to distributions is a red flag. A CPA can help you establish a defensible salary that maximizes your tax savings without creating IRS exposure.

LLC vs S-Corp: A Side-by-Side Comparison

Factor	LLC (default)	S-Corporation
Self-employment tax	On all net profit	On salary only
Payroll requirements	None	Yes — must run payroll
Administrative complexity	Low	Moderate to high
Annual tax return	Schedule C or Form 1065	Form 1120-S
State fees	Varies	Varies (often higher)
Best for	Lower income / simplicity	Higher income / tax savings

Can an LLC Be Taxed as an S-Corp?

Yes — and this is a common and effective strategy. You can form an LLC (for its legal simplicity and liability protection) and then elect to have it taxed as an S-Corporation by filing Form 2553 with the IRS.

This gives you the legal flexibility of an LLC with the tax treatment of an S-Corp. Most of our clients who make the S-Corp election use this structure.

The election must be filed by March 15 of the tax year you want it to take effect (or within 75 days of forming the entity). Late elections are possible in some circumstances.

Other Considerations

Retirement contributions: S-Corp owners can contribute to a Solo 401(k) or SEP-IRA based on their W-2 salary, which affects the maximum contribution amount. This interacts with the salary decision in ways that require careful planning.

State taxes: Some states do not recognize S-Corp status, or impose their own franchise taxes on S-Corps that can offset the federal savings. California, for example, imposes a 1.5% franchise tax on S-Corp net income (minimum $800). Always model the full picture, including state taxes.

Qualified Business Income (QBI) deduction: The 20% QBI deduction under Section 199A applies to both LLC and S-Corp income, but the calculation differs. In some cases, the interaction between salary, QBI, and self-employment tax creates a more complex optimization problem than the simple "pay yourself less" approach suggests.

The Bottom Line

The S-Corp election is one of the most powerful tax planning tools available to self-employed individuals and small business owners — but it is not automatic. The right answer depends on your income level, your state, your industry, your retirement planning goals, and your tolerance for administrative complexity.

If you are earning $50,000 or more in net self-employment income and have not evaluated whether an S-Corp election makes sense for you, it is worth a conversation. The potential savings are often significant — and the window to make the election for a given tax year is limited.

We offer a complimentary 30-minute consultation to walk through the numbers for your specific situation.