It’s one of the most common questions business owners ask, and the answer can mean thousands of dollars a year in tax. The confusion usually comes from mixing up two different things: a legal entity and a tax election.
They’re not the same category
An LLC is a legal entity formed at the state level. An S-Corp is a tax status you elect with the IRS. In fact, an LLC can choose to be taxed as an S-Corp, you don’t have to give up the LLC to get the tax benefit.
The tax difference that matters
A standard single-member LLC is taxed as a sole proprietorship: all net profit is subject to self-employment tax (about 15.3%) on top of income tax.
With an S-Corp election, you split your income into two parts:
- A reasonable salary, which is subject to payroll taxes, and
- Distributions, which are not subject to self-employment tax.
That split is where the savings come from.
A simplified example
Say your business nets $120,000. As a sole proprietor, nearly all of it faces self-employment tax. As an S-Corp, you might pay yourself a $70,000 reasonable salary and take $50,000 as distributions, saving self-employment tax on that $50,000.
The catch
S-Corps add cost and complexity: payroll, a separate business return, and the requirement to pay yourself a reasonable salary (the IRS scrutinizes this). The election generally makes sense once profits are high enough that the tax savings comfortably exceed those added costs, often around $40,000-$50,000 of net profit, but it depends on your situation.
Not sure if it’s time to elect S-Corp status? We’ll model the numbers for your business. Book a consultation.
Compare the operating costs as well as the tax model
Bring your current ownership structure, profit history, the work each owner performs, and any plans to add investors. Ask for a comparison that includes payroll, accounting, state obligations, legal coordination, and ongoing administration. A business structure should support how the company operates. A favorable example involving another owner's numbers is not enough to justify an election for your business.
General educational information, not an individual tax opinion. The applicable year, jurisdiction, and facts must be reviewed before acting.