LLC vs S-Corp: A Complete Tax Comparison Guide
Choosing the right business structure is one of the most consequential financial decisions a self-employed person makes. This guide explains how sole props, LLCs, and S-Corps are actually taxed — and how to determine which structure makes sense at your income level.
The Self-Employment Tax Problem
Employees split payroll taxes with their employer: each pays 7.65% (Social Security + Medicare), for a combined 15.3% on wages up to the Social Security wage cap ($168,600 in 2024). When you're self-employed, you pay both halves — the full 15.3% on 92.35% of your net self-employment income, then 2.9% above the wage cap.
This is self-employment (SE) tax, and it hits before federal and state income taxes. At $100,000 in net profit, SE tax alone is about $14,130. Add a 22% federal income tax bracket and you could be paying 35–38% federal taxes before any state liability. Understanding this math is the starting point for evaluating your entity options.
How Each Structure Is Taxed
Sole Proprietorship
The default structure for solo business owners. Business income is reported on Schedule C of your personal tax return. You pay SE tax on 92.35% of net profit, then ordinary income tax on the remainder (minus the SE tax deduction). Simple to operate — no formal registration, no separate business return — but carries unlimited personal liability and offers no SE tax relief.
Single-Member LLC (Default Taxation)
By default, a single-member LLC is a "disregarded entity" — it's treated identically to a sole proprietorship for tax purposes. Income flows to Schedule C, SE tax applies to all net profit, and you file the same forms as a sole prop. The LLC provides personal liability protection (your personal assets are shielded from business debts and judgments), but it provides zero tax benefit without an additional election.
Common misconception: forming an LLC does not reduce your taxes. Only making a tax election changes how you're taxed.
S-Corporation Election
Any LLC or corporation can elect S-Corp status by filing IRS Form 2553 (by March 15 for the current tax year). With S-Corp taxation, business profit is split into two buckets:
- Reasonable salary — Subject to payroll taxes (SE equivalent). You withhold and remit both employee and employer portions.
- Distributions — The remaining profit, paid as owner distributions. Distributions are subject to income tax but NOT payroll taxes.
The Reasonable Salary Requirement
The IRS requires S-Corp owner-employees who perform services for the business to pay themselves a "reasonable salary" before taking distributions. This is the most scrutinized aspect of S-Corp taxation — setting an artificially low salary to maximize untaxed distributions is an audit target.
"Reasonable" generally means what you would pay an arm's length employee to perform the same services. Common approaches:
- Research Bureau of Labor Statistics wage data for your occupation and region
- Use the 50–60% of net profit rule as a starting point for most service businesses
- Document your rationale — industry surveys, comparable job postings, etc.
- Work with a CPA who has S-Corp experience to set and defend your salary
The IRS has successfully recharacterized distributions as wages in court cases where owners paid themselves $0 or nominal salaries. The penalties include back payroll taxes plus interest. Don't cut corners here.
When S-Corp Election Makes Sense
S-Corp election adds administrative overhead: you must run payroll (quarterly), file Form 941 quarterly, file a separate S-Corp return (Form 1120-S) annually, and handle W-2 issuance. Professional fees for this typically run $2,000–$5,000/year above what you'd pay as a sole prop.
The break-even point is generally $50,000–$80,000 in annual net profit. Below that, compliance costs exceed tax savings. Above $80,000, S-Corp election typically saves several thousand dollars per year — savings that compound over a career.
| Net Profit | Est. SE Tax Savings | After $3K Compliance Costs |
|---|---|---|
| $50,000 | ~$3,800 | ~$800 |
| $80,000 | ~$6,100 | ~$3,100 |
| $120,000 | ~$9,200 | ~$6,200 |
| $200,000 | ~$11,500 | ~$8,500 |
Estimates assume 50% salary split and standard compliance costs. Actual results vary by situation.
The QBI Deduction (Section 199A)
The Qualified Business Income deduction allows eligible pass-through business owners to deduct up to 20% of qualified business income from taxable income. It applies to sole props, partnerships, LLCs, and S-Corps — but not C-Corps or wages.
Key limitations: the deduction phases out at higher incomes ($182,050 single / $364,200 married in 2024) and is limited or eliminated entirely for "specified service trades" — including law, health, financial services, consulting, and performing arts. It is currently scheduled to expire after 2025.
For eligible businesses, the QBI deduction effectively reduces your federal income tax rate on business profit by about 20%. Combined with S-Corp SE tax savings, the difference between an unoptimized sole prop and a properly structured S-Corp can be $10,000–$20,000/year for a six-figure service business.
Steps to Make the S-Corp Election
- Form an LLC in your state (if not already formed) — filing fees range from $50 to $500 depending on state
- Obtain an EIN (Employer Identification Number) from the IRS — free, takes minutes at IRS.gov
- File IRS Form 2553 (Election by a Small Business Corporation) — must be filed by March 15 for the current tax year, or within 75 days of forming the LLC for a new election
- Set up payroll — use a payroll service (Gusto, ADP, QuickBooks Payroll) to handle withholding and remittance
- Work with a CPA experienced in S-Corps to set your salary, file Form 1120-S annually, and issue yourself a W-2
Run Your Numbers
Compare your estimated tax obligation as a sole prop, LLC, and S-Corp based on your actual income.
Open LLC Tax Estimator →