S-Corp vs LLC

S-corporation is a tax election (Form 2553), not an entity type. An LLC is a state-law entity that defaults to pass-through taxation as a sole proprietorship (1 owner) or partnership (2+ owners). The same LLC can elect to be taxed as an S-corp by filing Form 2553 — the legal entity stays an LLC but the IRS taxes it under Subchapter S.

A default LLC owner pays 15.3% self-employment tax on every dollar of profit (up to the SS wage base, then 2.9% Medicare above). An S-Corp owner pays 15.3% only on the W-2 "reasonable compensation" portion; the remaining profit flows through as distributions, which are not subject to SE/FICA tax. On $100k of profit, that can save $7,000–$10,000 a year in payroll tax.

The IRS requires S-Corp owner-employees to take a salary that reflects the fair market value of services performed. There is no formula in the Code; case law uses comparable-position salaries, time spent, and industry data. The IRS audits S-Corps that pay implausibly low salaries (e.g., $15k W-2 on $300k profit) and reclassifies distributions as wages with payroll tax + penalties. Tools like RCReports and the Bureau of Labor Statistics OEWS database are commonly cited.

Annual costs typically include: payroll-processing service ($600–$1,500), Form 1120-S tax preparation ($800–$2,500 vs $300–$600 for Schedule C), state franchise/minimum tax ($800 in California, varies elsewhere), and bookkeeping for separate accountable plans. SE-tax savings need to clear ~$3,000–$5,000 of overhead before the election pays off — meaning roughly $40k–$60k of net profit is the rough break-even point.

Both default LLC and S-Corp owners can claim the Section 199A QBI deduction (20% of qualified business income, subject to phase-outs). For an S-Corp, only the distribution portion counts toward QBI — W-2 wages paid to yourself are not qualified business income. Above the SSTB phase-out thresholds ($241,950 single / $483,900 MFJ for 2025), reducing W-2 wages can reduce the QBI deduction, so the S-Corp election interacts with QBI in non-obvious ways for high earners.

The answer depends on plan design. A default LLC owner can contribute to a SEP IRA up to 25% of net SE earnings (after the SE-tax adjustment), or to a Solo 401(k) as both employee ($23,500 in 2025) and employer (25% of comp). An S-Corp owner can only base employer contributions on their W-2 wages, not distributions — so a low-salary S-Corp owner has lower retirement-plan capacity. See our SEP IRA vs Solo 401(k) calculator.

S-Corp election rarely pays for: (1) net profit under $40k–$50k (overhead exceeds savings); (2) businesses with high reasonable comp requirements (medical / legal / engineering — IRS expects $200k+ salaries); (3) owners who need maximum retirement contributions; (4) businesses with multiple non-resident owners (S-Corps cannot have foreign shareholders); (5) anyone planning to take VC investment (S-Corps cannot have entity owners or multiple share classes — see Form 2553 instructions).

File Form 2553 (Election by a Small Business Corporation) within 2 months and 15 days of the start of the tax year (March 15 for calendar-year taxpayers) to elect S-Corp status for the current year. Late elections can sometimes be cured with reasonable cause under Rev. Proc. 2013-30. Once elected, you must run payroll, file Form 941 quarterly, issue yourself a W-2, and file Form 1120-S annually.