S-Corp vs Sole Proprietor

A sole proprietorship is an unincorporated business owned by one individual. There is no separate entity for tax purposes — profit is reported directly on Schedule C of your personal Form 1040, and you pay 15.3% self-employment tax on net SE earnings up to the Social Security wage base ($176,100 for 2025) plus 2.9% Medicare above that.

The single biggest reason is to reduce SE/FICA tax. A sole prop pays 15.3% on every dollar of profit (up to the SS wage base). An S-Corp owner pays FICA only on the W-2 reasonable-compensation portion; the remaining profit flows through as distributions, free of SE/FICA tax. On $100k of profit, that typically saves $7,000–$10,000 a year.

Technically you can elect S-Corp on a sole proprietorship using Form 2553 + Form 8832, but in practice almost everyone forms an LLC (or files Articles of Incorporation) first because the S-Corp election requires a corporate-style entity for liability protection and state-level recognition. Forming an LLC is typically $50–$300 plus annual filing fees varying by state.

Typical annual costs: payroll-processing service like Gusto or ADP ($600–$1,500), Form 1120-S tax preparation ($800–$2,500 vs $300–$600 for Schedule C), state minimum tax ($800 in California, varies elsewhere), and quarterly Form 941 / annual W-2 / Form 940 unemployment filings. Net overhead increment over sole prop: roughly $1,500–$3,500 per year for a single-owner business.

The IRS requires S-Corp owner-employees to pay themselves a salary equal to the fair market value of services performed. There is no statutory formula — case law uses comparable salaries from BLS OEWS data, time spent, training, and industry norms. The IRS audits S-Corps that pay implausibly low salaries (e.g., $20k W-2 on $200k profit) and reclassifies distributions as wages with payroll tax, interest, and penalties.

For most single-owner service businesses, the S-Corp election starts to pay around $40,000–$60,000 of annual net profit. Below that, the $1,500–$3,500 of additional overhead exceeds the FICA savings. From $80,000 upward, savings typically run $5,000–$11,000 per year and grow until the Social Security wage base is hit (since FICA above $176,100 is only the 2.9% Medicare portion, S-Corp savings flatten above that level).

Both sole prop and S-Corp owners can claim the Section 199A QBI deduction — 20% of qualified business income subject to phase-outs above $241,950 single / $483,900 MFJ (2025). For an S-Corp, only the distribution portion counts as QBI; W-2 wages paid to yourself do not. For specified-service businesses (SSTBs — health, law, accounting, consulting) above the upper phase-out, the QBI deduction zeroes out, removing one of sole prop's offsetting advantages.

A sole prop can fund a Solo 401(k) with employee deferrals up to $23,500 (2025) plus 25% of net SE earnings as an employer contribution, capped at the $70,000 §415(c) limit. An S-Corp owner can only base the 25% employer match on W-2 wages, not on distributions — so a low-salary S-Corp owner has reduced retirement-plan capacity. Sole prop tends to win on raw retirement-plan space.