Strategy Snapshot
An LLC taxed as a sole proprietorship or partnership pays self-employment tax on all of its profit. Electing S-corp status splits profit into a reasonable salary (subject to payroll tax) and distributions (not subject to it), saving the 15.3% on the distribution portion. The election makes sense once that saving clears the added cost of running an S-corp, usually somewhere in the $40,000 to $80,000 profit range.
S-corp distributions escape the 15.3% self-employment tax. On $100,000 of profit with a $60,000 salary, the $40,000 distribution can save roughly $6,000 a year.
Running payroll, filing a separate 1120-S return, and added bookkeeping typically run $2,000 to $4,000+ a year. The election only pays once savings exceed this.
You must pay yourself a reasonable salary. Lowballing it to maximize distributions is the fastest way to attract an audit and lose the strategy.
“Should I become an S-corp?” is the most common tax question growing business owners ask, and it usually gets answered with a vague “once you’re making enough.” That is true but useless. The real answer is a calculation, and it comes down to one tension: the self-employment tax you save versus the cost and complexity you take on.
An S-corp election is worth it the moment your self-employment tax savings reliably exceed the extra cost of running one, and not a dollar of profit before.The decision in one line
Why the LLC Default Costs You
An LLC by itself is not a tax classification. A single-member LLC is taxed as a sole proprietorship; a multi-member LLC as a partnership. In both cases, all of your net profit is subject to 15.3% self-employment tax (Social Security and Medicare), on top of income tax.
That is fine when profits are modest. As profit climbs, that 15.3% on every dollar becomes the largest avoidable tax a small business owner faces.
What the S-Corp Election Changes
An S-corp election (made on Form 2553) sits on top of your existing LLC, you do not form a new entity or change anything legally. What changes is how profit is taxed:
- You pay yourself a reasonable salary as a W-2 employee, subject to payroll tax
- The remaining profit comes out as distributions, which are not subject to self-employment or payroll tax
That second bucket is the savings. The 15.3% that would have hit your entire profit now hits only your salary.
The Math, With Real Numbers
Consider an owner with $100,000 of net profit who pays a reasonable salary of $60,000:
| LLC (sole prop) | S-corp | |
|---|---|---|
| Profit | $100,000 | $100,000 |
| Salary (payroll-taxed) | n/a | $60,000 |
| Distribution (not payroll-taxed) | n/a | $40,000 |
| Subject to 15.3% SE/payroll tax | $100,000 | $60,000 |
| Approx. SE/payroll tax | ~$14,100 | ~$9,200 |
| Approx. annual saving | ~$5,000–$6,000 |
(The self-employment tax figure accounts for the deduction for the employer-equivalent portion; the exact number depends on your specifics.)
The Costs on the Other Side
The election is not free. An S-corp brings recurring obligations:
- Payroll: you must run formal payroll, with withholding and quarterly filings
- A separate tax return: Form 1120-S, in addition to your personal return
- More bookkeeping: cleaner books, a real balance sheet, reasonable-comp support
- State costs: some states impose franchise taxes or fees on S-corps
Realistically, these add $2,000 to $4,000 or more per year in payroll, software, and accounting. That cost is exactly why a low-profit business should wait.
Where the Breakeven Lands
The Non-Negotiable: Reasonable Salary
The entire strategy depends on paying yourself a reasonable salary. The temptation is to set it as low as possible to maximize the untaxed distribution, and that is precisely what the IRS watches for. An unreasonably low salary invites reclassification of your distributions as wages, plus back payroll taxes and penalties. Getting this number right, defensibly, is the heart of running an S-corp well. See S-corp reasonable salary for how to set and support it.
Two More Wrinkles Worth Knowing
- QBI interaction: your salary reduces the income eligible for the 20% QBI deduction, but for higher earners it can also be what preserves that deduction. The salary decision affects both taxes at once.
- Timing and late elections: the election generally must be filed within a window of the tax year, but late S-corp election relief can often fix a missed deadline retroactively.
When Staying an LLC Is the Right Call
The S-corp is not always the answer. Keep the simpler LLC when:
- Profit is below the breakeven and likely to stay there
- You are reinvesting most earnings rather than taking them out
- The business is new or volatile, and predictable profit has not arrived
- You value simplicity and want to avoid payroll and a second return
When to Seek Help
This is a calculation worth doing precisely, because both the savings and the costs are specific to you: your profit, a defensible salary, your state, and how the QBI deduction interacts. A one-time analysis tells you whether to elect now, wait a year, or file a late election for the current year, and sets the reasonable salary you can defend. For an owner near or above the breakeven, that conversation typically pays for itself in the first year and every year after.
Last updated: 2026