Of all the questions small business owners bring us, "should I be an LLC or an S-Corp?" is one of the most common — and one of the most misunderstood. Part of the confusion is structural: an LLC is a legal entity, while S-Corp is a tax election. You can actually be an LLC and elect to be taxed as an S-Corp. The real question isn't "LLC or S-Corp" — it's how you want your business income taxed.
How a default LLC is taxed
By default, a single-member LLC is taxed as a "disregarded entity" — its income flows straight through to your personal return on a Schedule C, exactly as if you were a sole proprietor. A multi-member LLC defaults to partnership taxation. In both cases, all of your net business profit is subject to self-employment tax, currently 15.3%, on top of ordinary income tax.
How an S-Corp election changes the math
When an LLC (or a corporation) elects S-Corp status, the owner becomes an employee of the business. You pay yourself a "reasonable salary" through payroll — subject to payroll taxes like any employee's wages — and the remaining profit can be distributed to you as a shareholder distribution, which is not subject to self-employment tax.
That distinction is the entire appeal of the S-Corp election: potential self-employment tax savings on the portion of profit paid out as distributions rather than salary.
The catch: "reasonable salary" isn't optional
The IRS requires that the salary you pay yourself be reasonable for the work you actually perform, based on your role, industry, and location. Set it too low purely to avoid payroll tax, and you're taking on real audit risk. This is one of the most common mistakes we see business owners make after electing S-Corp status without professional guidance — either overpaying in payroll taxes because the split wasn't optimized, or setting a salary low enough to draw IRS scrutiny.
The administrative cost of an S-Corp
An S-Corp election isn't free to maintain. Compared to a default LLC, you can expect:
- A separate business tax return (Form 1120-S) each year
- Ongoing payroll processing, including quarterly payroll tax filings
- More formal bookkeeping to track salary versus distributions correctly
- Additional preparation fees to reflect the added complexity
For a business with modest profit, those added costs can offset — or exceed — the self-employment tax savings. This is exactly why "when does it make sense" depends on your numbers, not a rule of thumb you read online.
When a default LLC is usually the better fit
- The business is newer or profit is still modest and inconsistent
- You want to minimize administrative overhead and cost
- Most of the profit needs to stay in the business or be reinvested rather than distributed
When an S-Corp election is worth exploring
- Net profit has grown to a level where the self-employment tax savings meaningfully outweigh the added payroll and filing costs
- You're comfortable running payroll (or outsourcing it) and keeping cleaner books
- You expect the higher profit level to hold, not just a single strong year
There isn't a single income number where this flips for everyone — it depends on your state, your industry, your reasonable salary, and your other business expenses. That's the kind of analysis we run for clients before recommending an election either way.
Don't forget state-level rules
S-Corp treatment isn't automatically mirrored at the state level. Some states don't recognize the S-Corp election at all, some impose their own entity-level taxes on S-Corps, and franchise tax or minimum fee structures vary widely. A structure that makes sense federally can look very different once state tax is factored in.
The election itself takes minutes to file. Getting the salary-versus-distribution split right, every year, is where the real value of a tax advisor shows up.
If you're weighing this decision, or you already made the election and aren't sure it's still the right call, we can run the numbers against your actual financials rather than a generic rule of thumb.
