"Should I be an LLC or an S-corp?" is one of the most common questions small business owners ask, and it's a slightly confused question — because an LLC is a legal entity structure, while S-corp is a tax election. In fact, an LLC can choose to be taxed as an S-corp. The real comparison isn't "LLC vs S-corp" so much as "default LLC taxation vs LLC taxed as an S-corp," and the difference between those two comes down almost entirely to self-employment tax.
Start with what each one actually is
| Term | What it actually is |
|---|---|
| LLC | A legal business structure formed at the state level, providing liability protection separate from the owner(s) |
| S-corp | A federal tax election (IRS Form 2553) that changes how an eligible entity — an LLC or a corporation — is taxed |
By default, a single-member LLC is taxed as a "disregarded entity" (like a sole proprietorship) and a multi-member LLC is taxed as a partnership. Either can elect S-corp taxation instead, without changing the underlying legal structure at all.
The core tax difference: self-employment tax
Under default LLC taxation, all of the business's net profit is subject to self-employment tax (Social Security and Medicare, currently 15.3% combined) — even profit you leave in the business and never take as a "salary."
Under an S-corp election, the owner must be paid a reasonable salary as a W-2 employee, which is subject to payroll taxes. But any remaining profit distributed to the owner beyond that salary is not subject to self-employment tax — only income tax. That gap is the entire reason S-corp elections exist as a tax strategy.
Simplified example: a business with $120,000 in net profit, taxed as a default LLC, owes self-employment tax on the full $120,000. Taxed as an S-corp with a $70,000 reasonable salary, self-employment-equivalent payroll tax applies only to the $70,000 salary — the remaining $50,000 distribution avoids it entirely. The exact savings depend on your numbers and current tax rates.
What "reasonable salary" means (and why it matters)
The IRS requires the salary to reflect what you'd actually pay someone else to do your job — based on role, industry, experience, and location. Setting the salary artificially low to dodge payroll tax is a well-known audit trigger; the IRS has successfully reclassified distributions as wages in enforcement cases specifically targeting under-salaried S-corp owners. This isn't a number to guess at — comparable salary data or a professional opinion is worth having on file.
The costs an S-corp election adds
- Payroll processing. Running yourself as a W-2 employee means actual payroll — tax withholding, payroll tax filings, and often payroll software or a service.
- A separate tax return. S-corps file Form 1120-S, which typically means additional accounting/tax prep cost compared to a default LLC's simpler filing.
- More rigorous bookkeeping. Salary and distributions need to be tracked and documented clearly, which is exactly the kind of structure a well-set-up chart of accounts supports.
- State-level variation. Some states impose their own franchise tax or fees on S-corps, which can offset part of the federal savings.
When the election tends to make sense
| Likely worth it | Probably not worth it yet |
|---|---|
| Consistent net profit well above a reasonable salary for your role | Profit is small, inconsistent, or reinvested entirely back into growth |
| You can absorb the added payroll and filing costs | The added compliance cost would eat most of the tax savings |
| You're comfortable documenting a defensible reasonable salary | You're not ready to run formal payroll and separate filings |
Many advisors use roughly $40,000-$60,000 in net profit as a rough point where the S-corp savings start to outweigh the added costs, but this varies significantly by state, industry, and individual numbers — it's not a one-size-fits-all threshold.
How this connects to how you pay yourself
The S-corp decision is closely tied to the broader question of how contractors and employees are classified and the mechanics of paying yourself as an owner — worth reading alongside this one if you're weighing the switch.
An S-corp election can be a genuinely good move, but only past a certain profit level and only if you're set up to handle the added payroll and filing requirements correctly. Running the actual numbers for your business — not a generic rule of thumb — is the only way to know if it pays off. Get in touch and we'll help you work out whether it makes sense for you.
Frequently Asked Questions
Is an S-corp a type of business entity like an LLC?
No — an LLC is a legal structure formed at the state level, while S-corp is a federal tax election. An LLC can elect to be taxed as an S-corp without changing its underlying legal structure at all.
How does an S-corp election save on taxes?
By splitting owner income into a reasonable salary (subject to payroll tax) and additional distributions (not subject to self-employment tax). Under default LLC taxation, all net profit is subject to self-employment tax regardless of how it's taken out.
What is a 'reasonable salary' for an S-corp owner?
It's the amount the IRS expects you to pay yourself based on what a similar role would earn in your industry and location. Setting it artificially low to avoid payroll tax is a known audit risk, so it should be documented and defensible, not guessed at.
This article is general information, not personalised tax, legal or accounting advice. Rules and thresholds change — confirm current-year figures with the IRS or a qualified professional before acting. Ask Accounts Buddy if you'd like help applying any of this to your business.