LLC vs S-Corp: which structure saves more on self-employment taxes?

An S-Corp election can save significant self-employment taxes compared to a default LLC — but only if your business earns enough to justify it. Here's how the math works:

Default LLC (sole proprietorship for tax purposes):

All net profit flows to your personal return on Schedule C and is subject to self-employment tax (SE tax) of 15.3% (12.4% Social Security + 2.9% Medicare) on the first $168,600 of earnings (2024), then 2.9% on amounts above that. Plus, you owe ordinary income tax on the full net profit.

S-Corp (LLC with S-Corp election via Form 2553):

As an S-Corp owner-employee, you split your income into two buckets:

• Reasonable salary: Subject to payroll taxes (same 15.3%, split between employer and employee portions)
• Distributions: NOT subject to SE/payroll taxes — only ordinary income tax

Example with $150,000 net profit:

• LLC: SE tax on $150,000 = ~$21,194 (after the 50% deduction)
• S-Corp with $80,000 salary: Payroll taxes on $80,000 = ~$12,240. The remaining $70,000 taken as distributions avoids SE tax. Savings: ~$8,954/year

When does an S-Corp make sense?

• Generally when net profit consistently exceeds $50,000–$60,000/year
• Below that threshold, the additional costs may outweigh savings

Additional S-Corp costs to consider:

• Payroll processing: $500–$2,000/year (Gusto, ADP)
• Additional tax return: Form 1120-S (~$500–$1,500 to prepare)
• Reasonable salary requirement: The IRS scrutinizes S-Corp owner salaries. Setting it too low triggers audits.
• State-level taxes: Some states (California) charge an $800+ annual franchise tax or impose additional S-Corp taxes
• Quarterly payroll tax filings (Forms 941)

The "reasonable salary" test:

The IRS requires your salary to be comparable to what similar businesses pay for similar services. Factors include your experience, hours worked, duties performed, and what comparable businesses pay. A general guideline is 50–60% of net profit, but it varies by profession.