LLC vs S-Corp: When the Election Saves $8K+ a Year

Priya is a software consultant in Austin, Texas. She files single, runs her business through a single-member LLC, and expects $120,000 of net profit this year. On her current default setup, she pays the full 15.3% self-employment tax on that profit — about $16,955 after the deductible-half adjustment — on top of regular income tax. If she files Form 2553 to have her LLC taxed as an S-corp, pays herself a $70,000 reasonable salary, and takes the remaining ~$50,000 as a distribution, her self-employment/payroll tax drops by roughly $7,650, and the net benefit after payroll and admin costs lands near $8,000–$10,000 a year. That single election is the whole story of LLC vs. S-corp taxation.

The one number that drives the whole decision: 15.3%

People treat “LLC vs. S-corp” as a fork between two business types. It is not. An LLC is a legal entity created under state law. An S-corp is a tax classification under federal law. They live on different layers. The same LLC can be taxed as a sole proprietorship, a partnership, or an S-corp — without ever changing its legal form.

Once you see that, the comparison simplifies to a single question: how is your profit taxed for Social Security and Medicare?

• Default LLC (Schedule C or partnership): you pay 15.3% self-employment tax on all net profit — 12.4% Social Security on earnings up to the $181,800 wage base, plus 2.9% Medicare with no cap (IRC §1401, §1402).
• S-corp: you pay payroll tax (also 15.3% combined employer + employee) only on your W-2 reasonable salary. Profit distributed above that salary is not subject to the 15.3% at all.

Regular federal income tax under the §1 brackets is identical in both cases — the profit hits your 1040 either way. The savings come strictly from carving distributions out of the Social Security and Medicare base.

Plain-English glossary (the three words that matter)

• Pass-through: the business pays no entity-level income tax. Profit “passes through” to your personal return and is taxed once at your individual rate. Both default LLCs and S-corps are pass-throughs — you do not lose this by electing S-corp.
• Reasonable compensation: the W-2 salary an outside employer would pay someone to do your job. The IRS requires S-corp owner-employees to pay this before taking distributions (IRC §162; long-standing IRS position and case law).
• Distribution: profit paid to you beyond your salary. In an S-corp this is not wages, so it escapes the 15.3% payroll tax. This is the dollar that creates the savings.

Worked example: $120K net profit, single filer, Texas

Back to Priya. Same business, same $120,000 of profit, same state — only the tax classification changes. Texas has no state income tax, so this isolates the federal payroll-tax effect cleanly.

*The default LLC base reflects the SE-tax rule that you multiply net profit by 92.35% before applying 15.3% (IRC §1402(a)(12)): $120,000 × 0.9235 = $110,820, then 15.3% ≈ $16,955.

With a more aggressive but still defensible $60,000 salary, the distribution rises to ~$60,000 and the gross payroll-tax savings climb to roughly $9,000–$9,500 before costs — the upper end of the “$8K+” headline. The salary you choose is the lever that sets your number, which is exactly why the IRS polices it.

Where the break-even sits: roughly $60K–$80K net profit

The election is not free. Running payroll, filing a separate Form 1120-S, and the extra bookkeeping typically cost $1,500–$3,000 a year. The S-corp only wins when payroll-tax savings beat that recurring cost. Here is how the math moves across income levels (assuming a salary near 50–60% of profit). The “saved” column shows the gross self-employment tax on the distribution (15.3% of the distribution up to the wage base); the precise net benefit runs a few hundred dollars lower after the 92.35% SE-base haircut on the LLC side and the compliance cost above:

**At $200,000 net profit the comparison shifts above the $181,800 Social Security wage base. A default LLC owes 12.4% Social Security only up to that base plus 2.9% Medicare on all earnings — roughly $27,900 in SE tax. An S-corp paying a $110,000 salary owes about $16,830 in payroll tax, so the election still saves roughly $11,000. The per-dollar savings rate is lower than at $120K because every distribution dollar above the wage base only escapes the 2.9% Medicare piece (plus the 0.9% Additional Medicare Tax that can apply over $200K single / $250K MFJ, IRC §3101(b)(2)) — the 12.4% Social Security has already maxed out on both sides. The S-corp still wins at high income; the dollars under the wage base just carry a bigger savings multiple than the dollars above it.

How an LLC actually becomes an S-corp (you keep the LLC)

This is the step that confuses most owners. You do not dissolve your LLC and form a corporation. You keep your LLC, its EIN, its bank accounts, and its operating agreement — and you change only how it is taxed.

1. File Form 2553 (Election by a Small Business Corporation). A single-member or multi-member LLC can file 2553 directly; the IRS treats it as also making the “check-the-box” corporate election. The deadline is generally 2 months and 15 days after the start of the tax year the election should take effect.
2. Missed the deadline? Late-election relief under Rev. Proc. 2013-30 lets you file up to 3 years and 75 days late with a reasonable-cause statement — commonly granted.
3. Set up payroll. Run yourself a real W-2 paycheck with withholding and quarterly Form 941 filings. This is the operational cost the break-even table accounts for.
4. File Form 1120-S annually for the entity, which issues you a Schedule K-1. Your profit still passes through to your personal 1040 — you remain a pass-through taxpayer.

What most people miss: the salary lever cuts both ways

The single biggest mistake owners make is treating the reasonable salary as a dial they can crank to zero. It is the opposite — it is the most audited number in the entire S-corp strategy.

• Set the salary too low and the IRS reclassifies your distributions as wages, then assesses back payroll tax, plus penalties and interest. There is no statutory percentage; courts look at what the role is worth. Document it with role-based market data (BLS Occupational Employment Statistics, salary surveys, comparable job postings) and keep that file.
• Set the salary too high and you give back the savings — every extra dollar of wages is a dollar exposed to the 15.3% you were trying to avoid.
• The QBI interaction. Your W-2 wages are not qualified business income (IRC §199A(c)), so a higher salary shrinks your §199A 20% QBI deduction. But wages also raise the W-2-wage limit that caps QBI once taxable income exceeds the 2026 thresholds of $201,750 single / $403,500 MFJ (IRC §199A(e)(2)). For most owners under those thresholds the QBI effect is a second-order tweak, not the driver — but model it before locking your salary.
• State payroll and franchise costs. A few states impose an S-corp franchise tax or minimum fee (for example, California’s 1.5% S-corp tax with an $800 minimum). In those states, shave the net benefit before deciding. In no-income-tax states like Texas, Florida, and Washington, the federal savings stand alone.

The owners who lose money on an S-corp are almost never the ones who picked the wrong entity. They are the ones who elected too early (below the break-even), skipped real payroll, or paid themselves an indefensible salary. The strategy is sound; the execution is where it breaks.

LLC vs. S-corp: the at-a-glance comparison

The decision lever

Pull your projected net profit and divide your strategy on a single threshold. Below roughly $60,000 of net profit, stay a default LLC — the SE-tax savings on a thin distribution will not clear the $1,500–$3,000 payroll-and-filing cost. Above roughly $80,000, file Form 2553, set a documented reasonable salary at the bottom of your defensible market range, and take the rest as distributions — that is where the $8K+ in annual savings lives. In the $60K–$80K gray zone, the deciding factor is whether your profit is stable enough to justify standing up payroll: if it is, elect; if your income is lumpy or you expect a down year, wait one more year and re-run the number.