LLC vs S-corp
The self-employment tax math, the $60K-to-$80K breakeven, the salary requirement, and the state-by-state gotchas. An honest look at when the S-corp election saves money and when it just adds paperwork without meaningful savings.
They're not alternatives
An LLC is a legal entity created by filing paperwork with a state's Secretary of State. An S-corp is a federal tax election made by filing Form 2553 with the IRS. They're different categories of thing, so "LLC vs S-corp" is a slightly confused question. What people usually mean: "Should my LLC be taxed as an S-corp instead of the default pass-through?"
Most "S-corps" you encounter in small business are actually LLCs that checked the S-corp election box. The LLC's state registration stays the same. Its legal structure stays the same. Only how the IRS treats its income changes. That change can save thousands per year in self-employment tax for profitable businesses, but it also introduces real administrative overhead (payroll, extra tax return, bookkeeping complexity) that eats into the savings for smaller operators.
The self-employment tax math, in concrete numbers
Self-employment tax is 15.3% on net business earnings (12.4% Social Security up to the 2026 wage base of $168,600, plus 2.9% Medicare on all earnings). A default-taxed LLC passes all net profit through to the owner as self-employment income, so the owner pays 15.3% on the entire profit (up to the cap).
An S-corp splits the owner's income into two categories. The owner-employee pays themselves a "reasonable salary" through payroll, which is subject to the full 15.3% SE tax (split as employer and employee payroll taxes). The remaining profit is taken as distributions, which are NOT subject to SE tax. The savings come from whatever portion of profit can defensibly be classified as distributions instead of salary.
| Net profit | Default LLC (Schedule C) | S-corp election ($60K salary, rest distribution) | Annual SE tax savings |
|---|---|---|---|
| $50,000 | $7,650 SE tax | $9,180 (salary only) + payroll admin cost | S-corp is worse. Don't elect. |
| $75,000 | $11,475 SE tax | $9,180 payroll tax (on $60K salary) | $2,295 saved, minus ~$1,500 admin |
| $100,000 | $15,300 SE tax | $9,180 payroll tax (on $60K salary) | $6,120 saved, minus ~$1,500 admin |
| $150,000 | $19,710 SE tax (cap on Social Security) | $14,000 payroll tax (on $90K salary) | $5,710 saved, minus ~$2,000 admin |
| $250,000 | $22,625 SE tax (cap) | $18,360 payroll tax (on $120K salary) | $4,265 saved, minus ~$2,500 admin |
Numbers are rough and assume a reasonable salary at the lower end of defensible range. Actual savings depend on what salary is reasonable for your specific role, your state, and whether you have other wage income hitting the Social Security cap. A CPA can dial this in precisely.
Who the election fits
Service businesses earning $75K to $250K
Consultants, agencies, freelancers, coaches. Most of the work is the owner's labor, so a large portion of profit is arguably salary (not distribution), but there's usually enough margin above market salary to extract real distributions. This is the S-corp sweet spot.
Product businesses with reliable profit
E-commerce shops, SaaS tools, digital products. If profit is consistently above $60K and there's a clear distinction between owner labor and business earnings, S-corp works well. Volatile profit years make the payroll administration less worth it.
Real estate professionals
Mortgage brokers, real estate agents, and property managers with high commission income are classic S-corp candidates. Commission income above $80K typically justifies the election. Note: passive rental LLCs usually don't benefit because rental income is already exempt from SE tax.
Who the election does not fit
Side hustles and low-revenue businesses
Under $50K in net profit, payroll and tax-return administration costs typically exceed the SE tax savings. Stay as a default LLC (Schedule C) until revenue grows.
Businesses with non-US or corporate owners
S-corp requires all owners to be US individuals or specific types of trusts. If any owner is a non-resident alien, foreign company, or another corporation, the S-corp election is not available. Check eligibility before filing Form 2553.
Businesses planning to raise capital
S-corps can only have one class of ownership. If you plan to raise priced rounds with preferred stock, you need a C-corp, not an S-corp. Early-stage S-corps often have to revoke the election and reorganize as C-corps to accommodate investors, which is expensive.
Passive income businesses
Real estate rental LLCs, holding companies, investment LLCs. Passive rental income is not subject to self-employment tax in the first place, so S-corp election doesn't help. The extra compliance burden is pure cost with no benefit.
Common S-corp mistakes
- Paying yourself too little salary
The most audited S-corp issue. "Reasonable salary" means market rate for your job function. Paying yourself $25K on $200K in profit is not defensible. The IRS can reclassify distributions as wages plus penalties, interest, and FICA back-taxes.
- Missing the Form 2553 deadline
Election must be filed within 75 days of the start of the tax year (or the LLC's formation for a new LLC) to apply to that year. Missing the window defers the election by 12 months. Late elections can sometimes be saved under IRS Rev. Proc. 2013-30 with reasonable-cause justification, but don't count on it.
- Treating payroll as optional
An S-corp owner-employee has to run actual payroll with withholding, Form 941 quarterly filings, and W-2s. Some owners try to skip this and "just take distributions" all year, which invalidates the election. Gusto, QuickBooks Payroll, and similar services handle this for $40 to $100/month.
- Mixing business and personal accounts
S-corps have stricter recordkeeping expectations than sole props or default LLCs. Mixing personal expenses into the corporate account invites IRS scrutiny and can result in disallowed deductions. Separate accounts, clean books, consistent reimbursement policy.
- Electing too early
At $30K net profit, S-corp is a net loss after compliance costs. Wait until your revenue is reliably above the breakeven before electing. Revoking the election later triggers a five-year waiting period before you can re-elect.
State-by-state considerations
Federal S-corp election doesn't always translate cleanly at the state level. A handful of states either don't recognize S-corp status for tax purposes or impose additional entity taxes that reduce the benefit:
California ($800 FTB minimum + 1.5% on S-corp profit)
California imposes a 1.5% S-corp tax (minimum $800) on net income, on top of the regular $800 LLC franchise tax. For California LLCs, the S-corp election often costs more at the state level than it saves federally. Run the math carefully with a California CPA. See California formation.
New York City (UBT of 4% on unincorporated business)
NYC's Unincorporated Business Tax applies to LLCs but not S-corps. Electing S-corp can save the 4% UBT for NYC-based owners. This is one of the clearer state-level wins for electing.
Tennessee (franchise and excise tax)
Tennessee imposes a franchise tax (0.25%) and excise tax (6.5%) on S-corps and LLCs. Electing S-corp doesn't help you avoid these. Tennessee is one of the states where S-corp election is close to neutral.
Texas (margin tax threshold)
Texas doesn't have personal income tax and imposes a "franchise" (margin) tax of 0.375% to 0.75% on businesses earning over $2.47M. Most small S-corp-electing LLCs stay under that threshold. Texas is a good state for S-corp election because there's no state income tax to interfere.
New Hampshire (BPT and BET)
New Hampshire's Business Profits Tax (7.5%) and Business Enterprise Tax (0.55%) apply to S-corps. There's no personal income tax to offset against, so S-corp election doesn't move the needle much in New Hampshire.
Most other states
The rest follow the federal election straightforwardly. S-corp profits pass through to the owner's state personal tax return in most of the country, which is the result you want.
How to actually make the election
- Confirm eligibility
100 or fewer owners, all US individuals or eligible trusts, one class of ownership, a domestic LLC. If any condition fails, S-corp election is not available.
- File IRS Form 2553
Signed by all LLC members. Must be filed within 75 days of the start of the tax year for the election to apply to that year. For a new LLC, 75 days from formation. Mail it to the IRS address listed on the form (no online filing).
- Set up payroll
Before year-end, establish payroll for yourself as an owner-employee. Gusto, QuickBooks Payroll, Patriot, and ADP all handle this. Payroll processors handle Form 941 quarterly filings, W-2s, and state payroll tax registration.
- Open a payroll bank account
Separate from the operating account. Transfer enough each pay period to cover gross wages plus employer payroll taxes. Distributions can come from the operating account directly.
- File Form 1120-S annually
The S-corp tax return. Usually handled by a CPA. Schedule K-1s are issued to each owner showing their share of distributions. Due March 15 (not April 15 like personal returns).
Frequently Asked Questions
-
What's the difference between an LLC and an S-corp?
An LLC is a legal entity (created by filing paperwork with the state). An S-corp is a federal tax election (created by filing Form 2553 with the IRS). They're not alternatives; you can have both at the same time. Most "S-corps" you hear about are actually LLCs that elected S-corp tax treatment. The question is rarely "LLC or S-corp?" It's "should my LLC elect S-corp tax treatment?"
-
At what income level does S-corp election save money?
The rough rule of thumb is $60K to $80K in net business profit per year. Below that, the administrative costs (payroll processing, extra tax return, bookkeeping complexity) typically exceed the self-employment tax savings. Above it, the savings start to meaningfully outweigh the costs. Above $150K, the election becomes close to mandatory from a pure tax-efficiency standpoint. The exact breakeven depends on your state and your reasonable salary level.
-
What's the salary requirement in an S-corp?
The IRS requires S-corp owner-employees to pay themselves a "reasonable salary" before taking distributions. Reasonable means what you'd pay someone else to do your job in your market. Undersalaring yourself (common trick) is the most frequently audited S-corp issue, and the IRS can reclassify distributions as wages plus penalties. If you make $120K and pay yourself a $30K salary, expect scrutiny. A $75K salary with $45K in distributions is defensible.
-
How much does an S-corp election cost?
The election itself is free (Form 2553 is just paperwork). The ongoing cost is payroll processing ($40 to $100/month via Gusto, QuickBooks, or similar) plus the extra tax return complexity (Form 1120-S instead of Schedule C, typically $400 to $1,500/yr in CPA fees). Most S-corp owners spend $1,500 to $3,000 per year on administrative overhead compared to a single-member LLC filing Schedule C. The savings have to exceed this overhead to make the election worth it.
-
Can any LLC elect S-corp treatment?
Most can, if they meet the S-corp rules: 100 or fewer owners, all US individuals or certain trusts (no corporations or foreign owners), only one class of ownership. Filing Form 2553 within 75 days of the LLC's formation or the start of the tax year makes the election effective for the full year. Missing the deadline defers the election by a year. The LLC keeps its state-level registration as an LLC; only the federal tax treatment changes.
-
Is the S-corp election permanent?
No. You can revoke it by filing a statement with the IRS. If you revoke, you generally cannot re-elect S-corp status for five years without IRS consent. The election also terminates automatically if the LLC hires non-US-resident owners or adds a corporate owner. Plan for the election to be a multi-year commitment, and revisit it if revenue drops below the breakeven threshold.
-
Does the S-corp election change state taxes?
It depends on the state. Most states honor the federal election and treat the LLC as an S-corp at the state level too. A few states (notably Alabama, Arkansas, California, and others) either don't recognize S-corp status or impose a separate franchise tax that reduces the benefit. Tennessee, Texas, DC, and New Hampshire are states where S-corp election helps less than it does federally. Always check your state's specific treatment before electing.
-
What about LLC vs C-corp?
C-corp taxation is different from S-corp. A C-corp pays corporate income tax (21% federal) on profits, and shareholders pay personal tax on dividends, creating "double taxation." C-corp election for an LLC rarely makes sense for a small business. It becomes relevant only if you're raising institutional capital (VCs and most investors require C-corp structure, not S-corp or LLC) or if you want to retain significant profits inside the entity for reinvestment. For nearly all solo and small operators, C-corp election is the wrong choice.
-
Can I start as an LLC and elect S-corp later?
Yes, and this is the most common path. Start as a default-taxed single-member LLC (Schedule C), watch revenue. Once net profit reliably exceeds $60K to $80K, file Form 2553 to elect S-corp treatment. The election can be made by March 15 of any tax year to apply to the full year, or within 75 days of the start of the year. Retroactive elections back to the start of the year are also possible under IRS Rev. Proc. 2013-30 with reasonable-cause justification.