Every few weeks, a client walks into Dahir Tax & Accounting Firm asking the same question: should I switch my LLC to an S corp?
The honest answer is that it depends on your profit, your industry, and how much paperwork you’re willing to take on.
Below, we break down the actual mechanics of how each structure is taxed, where the real savings come from, and where an S corp election can end up costing you more than it saves.
Key Points
- An S corp election can lower your self-employment tax bill, but only on profit above what the IRS considers a reasonable salary.
- The added payroll and tax preparation costs of an S corp typically only pay for themselves once net profit clears roughly $60,000 to $80,000 a year.
How Each Structure Is Actually Taxed
An LLC is not a federal tax classification. It’s a state law entity, and by default the IRS taxes a single member LLC as a sole proprietorship and a multi member LLC as a partnership.
Profit flows straight to your personal return on Schedule C or Schedule E, and every dollar of net profit is subject to self-employment tax on top of ordinary income tax. An S corp is a tax election, not a legal entity type. You can file Form 2553 to have an LLC or a corporation taxed as an S corp.
Once you do, the business pays you a salary through payroll, and any remaining profit passes through to you as a distribution that is not subject to self-employment tax.
| Feature | Default LLC (Sole Prop/Partnership) | LLC Taxed as S Corp |
|---|---|---|
| Self-employment tax | Applies to all net profit | Applies only to salary, not distributions |
| Payroll required | No | Yes, for any owner who works in the business |
| Tax return filed | Schedule C or 1065 | Form 1120-S |
| Annual compliance cost | Lower | Higher (payroll, separate return, reasonable salary documentation) |
| QBI deduction eligibility | Yes, subject to income limits | Yes, subject to income limits |
Where the Savings Actually Come From
Let’s do the math instead of talking around it. The self-employment tax rate is 15.3%, made up of 12.4% for Social Security and 2.9% for Medicare, applied to 92.35% of your net earnings.
For 2026, the Social Security portion applies to the first $184,500 of combined wages and self-employment income; earnings above that are still subject to the 2.9% Medicare piece, and high earners pay an additional 0.9% Medicare tax once income crosses $200,000 for single filers or $250,000 for married filing jointly.
Say your LLC nets $120,000 in profit. As a sole proprietor, your self-employment tax is roughly $16,955 (15.3% of $110,820, which is 92.35% of $120,000). Now say you elect S corp status, pay yourself a $70,000 salary, and take the remaining $50,000 as a distribution.
Payroll tax on that salary, split between you as the employee and the business as the employer, comes to about $10,710. You’ve cut roughly $6,245 off your tax bill in that scenario. That gap is where the “S corp saves you money” advice comes from, and in a vacuum, it’s accurate.
Reasonable Salary: The Part Most Articles Skip
Here’s the catch. The IRS requires that your S corp salary be “reasonable” compensation for the work you actually do, and it has pursued this issue in court repeatedly. You can’t pay yourself $20,000 and call the remaining $100,000 a distribution just to dodge payroll tax.
Revenue Ruling 74-44 established the principle, and cases like Watson v. Commissioner (2012) show the IRS successfully reclassifying distributions as wages when the salary looked artificially low relative to the work performed.
Reasonable salary is typically benchmarked against what a similarly skilled employee would earn doing your job in your industry and location.
- Look at Bureau of Labor Statistics wage data or industry salary surveys for your role.
- Document the hours you actually work and the specific duties involved.
- Keep the analysis in writing every year, not just when you set up the S corp.
Underpaying yourself to inflate distributions is one of the more common audit triggers we see, and the penalties for getting caught go beyond just the back payroll tax. There’s also interest and, in some cases, accuracy related penalties.
What an S Corp Costs You That an LLC Doesn’t
The savings above are gross, not net. Running payroll costs money. Most payroll providers charge somewhere between $40 and $150 a month depending on the number of employees and the level of service.
A separate 1120-S return generally costs more to prepare than a Schedule C, often by several hundred dollars, because it requires its own set of books, a balance sheet, and shareholder basis tracking.
Some states also charge separate franchise or minimum taxes on S corps that they don’t charge on default LLCs. California, for example, imposes a 1.5% tax on net income with a $800 minimum, regardless of profit.
Add it up and the extra cost of an S corp election typically runs $1,500 to $3,000 a year once you count payroll processing, additional accounting work, and any state level fees. That’s why the breakeven point matters more than the headline savings number.
When the Numbers Actually Favor an S Corp
Based on the compliance costs above, an S corp generally starts making sense once net profit is consistently above $60,000 to $80,000 a year, and the advantage grows as profit climbs. Below that range, the extra payroll and accounting costs tend to eat most or all of the self-employment tax savings.
We’ve had clients elect S corp status at $45,000 in net profit because a well meaning blog post told them to, and the math simply didn’t support it once we ran their actual numbers.
The Qualified Business Income deduction under Section 199A adds another layer. It lets many pass-through owners, LLCs and S corps alike, deduct up to 20% of qualified business income, and the One Big Beautiful Bill Act made this deduction permanent starting in 2026 rather than letting it expire as originally scheduled.
For 2026, the deduction phases out starting around $201,750 in taxable income for single filers and $403,500 for joint filers.
Because S corp salary reduces qualified business income (distributions still count, but wages paid to the owner don’t), an aggressive S corp salary can actually shrink your QBI deduction even as it lowers your self-employment tax.
The two provisions pull in opposite directions, which is exactly the kind of interaction a spreadsheet catches and a general assumption misses.
The Bigger Picture
S corp elections are common enough that the IRS tracked 6,080,370 Form 1120-S returns filed in fiscal year 2024, up 3.4% from the year before, according to the IRS Data Book. That growth tells you the strategy works often enough to keep gaining ground, not that it works for everyone.
We’ve seen owners in service businesses, contractors, and single member consulting practices benefit meaningfully. We’ve also seen new business owners elect S corp status in their first year, before they had steady profit, and end up paying more in compliance costs than they saved in tax.
Conclusion
An S corp election can lower your tax bill, but only once your profit is high enough and your reasonable salary is documented correctly.
Run your actual numbers before you file Form 2553, or have someone at Dahir Tax & Accounting Firm run them with you.
