The S-Corp Confusion
You've heard you can save thousands in taxes with an S-Corp election. Maybe you should do it. Maybe it's complicated. This guide cuts through the confusion.
Understanding the Basics
LLC: A legal structure that provides liability protection. By default, taxed as a sole proprietor (or partnership if multiple members).
S-Corp: A tax election, not a legal structure. An LLC can elect to be taxed as an S-Corp while remaining an LLC legally.
Key insight: You don't choose between LLC and S-Corp. You can have an LLC that's taxed as an S-Corp.
Why S-Corp Saves Money
As a sole proprietor, you pay self-employment tax (15.3%) on all your profit. As an S-Corp:
- You pay yourself a 'reasonable salary'
- Self-employment tax only applies to that salary
- Remaining profit is distributions — no self-employment tax
Example: $150K profit
- As sole proprietor: ~$21K in self-employment tax
- As S-Corp with $80K salary: ~$12K in payroll taxes
- Savings: ~$9K per year
When S-Corp Makes Sense
- Consistent profit above $50-60K: Below this, the savings don't justify the complexity
- Predictable income: Wildly variable income makes salary determination difficult
- Willing to run payroll: You'll need to process payroll for yourself, including quarterly taxes
When to Stay a Simple LLC
- New business: Wait until you have consistent, predictable profit
- Low profit: Administrative costs may exceed tax savings
- Complexity averse: S-Corp adds ongoing requirements
The 'Reasonable Salary' Requirement
The IRS requires S-Corp owners to pay themselves a 'reasonable salary' for the work they do. You can't pay yourself $10K salary and take $140K in distributions.
Reasonable salary factors:
- What would you pay someone else to do your job?
- Industry norms for similar roles
- Your experience and responsibilities
Making the Switch
- Consult with a CPA to run the numbers for your situation
- File Form 2553 with the IRS (can be done for current year if filed within 75 days)
- Set up payroll for yourself
- Adjust estimated tax payments
The decision isn't permanent. If S-Corp stops making sense, you can revoke the election. But getting it right the first time saves headaches.