LLC vs S-corp: when the tax election pays off
An LLC is a state law concept. S-corp is a federal tax election. You can be both. By default, a single-member LLC is taxed as a sole proprietorship (Schedule C); a multi-member LLC is taxed as a partnership (Form 1065). Either can elect S-corp tax status by filing Form 2553.
The SE-tax angle
As a sole prop or partnership, all profits flow through to the owner and are subject to self-employment tax (15.3%) on top of income tax. As an S-corp, only the "reasonable salary" you pay yourself is subject to payroll tax — the rest can come out as a distribution that skips SE tax entirely.
The break-even math
S-corp election typically pays off when net profit clears $80,000–$100,000. Below that, the savings don't cover the added cost of payroll processing ($600–$1,200/year), separate corporate tax return ($500–$1,500/year), and reasonable-salary documentation. Above that, the SE-tax savings compound.
The "reasonable salary" trap
The IRS requires S-corp owners to pay themselves a "reasonable salary" before taking distributions. Set it too low and the IRS reclassifies distributions as wages (with back-tax + penalty). Most CPAs benchmark against the BLS wage data for your role + region — typically 30–60% of net profit, depending on the business.
When NOT to elect S-corp
- Net profit under $80k — savings don't justify added cost
- You're a non-US resident — S-corp requires US shareholders only
- You plan to take VC investment — S-corps can't have institutional investors