LLC vs. S-Corp: Which Saves More on Taxes for a Small Business?

Once a small business starts making real money, someone inevitably says: "You should be an S-corp." It is one of the most repeated pieces of tax advice for small business owners, and one of the most misunderstood. An S-corp election can save a profitable business thousands of dollars a year in self-employment tax. It can also add cost and complexity for no benefit at all if your profit is not high enough. Here is the actual math, in plain English.

First, an LLC and an S-corp are not the same kind of thing

This is the source of most of the confusion. An LLC is a legal entity, created at the state level, that separates your personal assets from your business liabilities. An S-corp is a tax election, made with the IRS on Form 2553, that changes how your business income is taxed. They are not competing options on the same list. An LLC can elect to be taxed as an S-corp and keep its LLC legal structure entirely intact. That is exactly what most small businesses that "become an S-corp" actually do.

So the real question is not LLC or S-corp. It is: should my LLC keep its default tax treatment, or elect S-corp taxation?

How a default LLC is taxed

By default, a single-member LLC is treated as a sole proprietorship for tax purposes and a multi-member LLC is treated as a partnership. In both cases the business itself pays no federal income tax. All profit passes through to the owners and is reported on their personal returns.

The catch is self-employment tax. Every dollar of net profit from a default LLC is subject to self-employment tax of 15.3%, which covers Social Security (12.4%) and Medicare (2.9%). This is on top of ordinary income tax. The Social Security portion only applies up to the annual wage base, which the Social Security Administration adjusts each year ($176,100 for 2025), while the 2.9% Medicare portion applies to all net earnings with no cap.

How an S-corp election changes the math

When your LLC elects S-corp taxation, you stop being a self-employed owner in the eyes of the IRS and become an employee of your own business. You must pay yourself a reasonable salary through actual payroll, with payroll taxes withheld. The profit left over after that salary is distributed to you as a shareholder distribution, and distributions are not subject to self-employment or payroll tax.

That is the entire savings mechanism. You are converting a portion of income that would have been hit with 15.3% self-employment tax into distributions that are not. Note that you still pay ordinary income tax on all of it, salary and distributions alike. The S-corp election saves you self-employment tax, not income tax.

A worked example

Say your business nets $150,000 in profit. As a default LLC, roughly the full $150,000 is subject to self-employment tax, costing you about $21,200 (the effective rate is slightly under 15.3% because half of SE tax is deductible against income tax). As an S-corp paying yourself a $75,000 reasonable salary, payroll taxes apply only to that $75,000, costing about $11,475, and the remaining $75,000 comes to you as a distribution with no SE tax. That is roughly $9,000 to $10,000 in annual savings before the added costs of running an S-corp.

The S-corp election reduces self-employment tax only. It does not reduce your income tax. Anyone promising an S-corp will slash your total tax bill is overselling it.

The costs an S-corp adds

• A separate business tax return (Form 1120-S) every year, in addition to your personal return
• Real payroll: a payroll service, quarterly Form 941 filings, W-2s, and state payroll registrations
• Higher bookkeeping and accounting fees, commonly $1,500 to $3,000 per year in combined additional cost
• Strict corporate formalities and a separate business bank account, since commingling funds undermines the election
• A hard filing deadline: S-corp returns are due March 15, a month earlier than personal returns

The reasonable salary requirement

This is where S-corp owners get into trouble. The IRS requires that you pay yourself a "reasonable" salary for the work you actually perform before taking distributions. Owners who pay themselves a token $20,000 salary on $200,000 of profit are the classic audit target. The IRS can reclassify distributions as wages and assess back payroll taxes, penalties, and interest.

There is no formula in the tax code, but reasonable compensation is generally supported by market data for your role, industry, geography, and hours worked. Documenting how you arrived at your number, using comparable salary data, is the single best protection if the IRS ever asks.

When does an S-corp election actually pay off?

The common rule of thumb is that an S-corp election starts making sense somewhere around $80,000 to $100,000 in annual net profit, after you have paid yourself a reasonable salary. Below that, the self-employment tax savings often do not cover the extra payroll, filing, and accounting costs. Well above that, the savings compound every year.

That threshold is a starting point, not a rule. Your state matters: some states impose franchise taxes or do not recognize the S-corp election, which erodes the benefit. Your health insurance situation matters, since S-corp owner premiums are handled differently. And the qualified business income deduction under Section 199A, which can be worth up to 20% of qualified business income, interacts with your salary level in ways that can change the answer.

How we approach this at Stone Valley Accounting

This is a decision that should be run as a projection, not a rule of thumb. At Stone Valley Accounting we model both scenarios using your actual year-to-date numbers: what you would owe as a default LLC, what you would owe as an S-corp at a defensible salary, and what the added compliance costs would be. If the election makes sense, we handle the Form 2553 filing, set up payroll, and build the reasonable compensation documentation. If it does not make sense yet, we tell you what profit level would change that and revisit it in a quarterly planning session.

One timing note worth knowing: Form 2553 is generally due within two months and 15 days after the beginning of the tax year you want the election to take effect, which for a calendar-year business means around March 15. Late elections can sometimes be granted relief, but planning ahead is far cleaner.