This is the single most common tax question we get from growing businesses — and the answer is often thousands of dollars. But the internet is full of oversimplified 'just make an S-Corp' advice that ignores the break-even math and the ongoing costs. Let's do it properly.
First, clear up the confusion
LLC and S-Corp are not the same kind of thing. An LLC is a legal entity you form with your state. An S-Corp is a tax election you make with the IRS. An LLC can choose to be taxed as an S-Corp — you keep the legal LLC and change how the IRS taxes it. So the real question isn't 'LLC or S-Corp,' it's 'should my LLC elect S-Corp taxation?'
Why the S-Corp election saves tax
As a default LLC (sole proprietor or partnership), all of your net profit is subject to self-employment tax — 15.3% for Social Security and Medicare — on top of income tax. That's the piece an S-Corp attacks.
With an S-Corp election, you split your profit into two buckets: a reasonable salary you pay yourself through payroll (which is subject to the 15.3% payroll tax), and distributions (which are not). Income tax still applies to both, but you legally avoid self-employment tax on the distribution portion.
Say your business nets $120,000. As a default LLC, roughly 15.3% self-employment tax applies to most of it. As an S-Corp, you might pay yourself a $70,000 reasonable salary and take $50,000 as distributions. You save the 15.3% on that $50,000 — about $7,650 before the extra costs.
The costs the internet forgets
- Payroll — you must run real payroll and file quarterly payroll tax returns, which usually means a payroll service or accountant.
- A separate business tax return — the S-Corp files Form 1120-S, which costs more to prepare than a Schedule C.
- Reasonable salary compliance — pay yourself too little and the IRS can reclassify your distributions and hit you with back taxes and penalties.
- State fees — some states charge extra franchise taxes or fees on S-Corps.
Add those up and you're often looking at $1,500–$3,000 a year in extra compliance costs. That's exactly why the election only makes sense once your profit is high enough for the savings to clear that hurdle.
The break-even point
As a general rule, the S-Corp election starts to pay off once your net profit is reliably above $60,000–$80,000 a year. Below that, the payroll and filing costs eat most of the savings. Well above it, the savings can reach five figures annually. But 'reliably' matters — a one-off good year isn't a reason to restructure.
The reasonable salary is where most DIY S-Corps get into trouble. Too low to save tax, too aggressive to defend in an audit.
Setting your reasonable salary
The IRS requires S-Corp owner-employees to pay themselves a 'reasonable' salary for the work they do — what you'd have to pay someone else to do your job. There's no magic percentage, despite what you'll read online. Factors include your role, hours, experience, and what comparable positions pay in your industry and region. An accountant documents this so it holds up if questioned.
So which is right for you?
- 1Net profit under ~$50,000 — usually stay a default LLC. The S-Corp costs outweigh the savings.
- 2Net profit $60,000–$80,000 and climbing — run the numbers; the election often starts to make sense here.
- 3Net profit well above $80,000 and stable — the S-Corp election frequently saves thousands per year.
This is a decision worth modeling with actual numbers, not a rule of thumb. We'll run your specific figures — including the payroll and filing costs — and tell you honestly whether the election saves you money this year. Book a free consultation and we'll do the math together.