S-Corp vs LLC: Which Saves More on Taxes?

If you're self-employed and earning more than about $60,000-80,000 in net profit, you've probably heard that an S-Corp election can save you thousands in taxes. That's true — for some people. For others, the compliance costs and complexity eat the savings. Here's how to figure out which camp you're in.

The Core Tax Difference

As a sole proprietor or single-member LLC (taxed as a sole proprietorship), you pay 15.3% self-employment tax on all your net business profit. That's 12.4% Social Security (up to $176,100 for 2026) plus 2.9% Medicare.

As an S-Corp, you split your business income into two buckets: a "reasonable salary" that you pay yourself (subject to payroll taxes) and distributions of remaining profit (not subject to SE/payroll tax). The salary portion gets hit with the same 15.3% in payroll taxes, but the distributions avoid it entirely.

The savings come from the distributions — every dollar you can legitimately classify as a distribution rather than salary avoids the 15.3% payroll tax. On $40,000 of distributions, that's roughly $6,120 in tax savings.

A Real Example

Let's compare a freelance consultant earning $120,000 net profit:

The "Reasonable Salary" Requirement

The IRS requires S-Corp owners who perform services for the company to pay themselves a "reasonable salary" before taking distributions. You can't pay yourself $10,000 on $200,000 of profit and call the rest distributions — the IRS will reclassify the income and charge back-taxes plus penalties.

"Reasonable" means comparable to what a similar role pays in the market. For a freelance web developer earning $150,000, a $50,000 salary would likely be challenged. A $90,000-110,000 salary is more defensible. For a consultant earning $80,000, the salary needs to be high enough that the remaining distribution isn't unreasonably large — perhaps $55,000-65,000.

The higher your reasonable salary needs to be relative to your total income, the less you save. This is why the S-Corp strategy becomes more powerful at higher income levels.

S-Corp Compliance Costs

Running an S-Corp isn't free. The ongoing costs you need to account for include: payroll processing ($30-100/month through Gusto, ADP, or similar), S-Corp tax return preparation ($500-1,500/year — an S-Corp files its own Form 1120-S in addition to your personal return), registered agent service ($100-300/year if required by your state), annual state filing fees and franchise taxes (varies by state — California charges an $800 minimum franchise tax), and potentially higher accounting fees throughout the year.

Realistic all-in compliance costs range from $2,000-4,000/year for most solo S-Corp owners. Your tax savings need to exceed these costs to make the election worthwhile.

The Breakeven Point

As a rough rule of thumb, the S-Corp election typically starts making financial sense when your net self-employment income is above $60,000-80,000 per year. Below that, the compliance costs eat most or all of the payroll tax savings. The exact breakeven depends on your specific salary requirements, state fees, and accountant costs.

The sweet spot — where savings are most significant relative to hassle — tends to be in the $100,000-250,000 range. Above $176,100 (the Social Security wage base), the marginal savings rate drops from 15.3% to just 2.9% on additional distributions, since only Medicare applies.

LLC vs S-Corp: They're Not Mutually Exclusive

A common misconception is that LLC and S-Corp are competing choices. They're actually different things: an LLC is a legal entity structure (providing liability protection), while S-Corp is a tax election (determining how you're taxed).

You can form an LLC and then elect S-Corp tax treatment by filing Form 2553 with the IRS. This gives you the legal protection of an LLC with the tax benefits of an S-Corp. Most solo self-employed people who "become an S-Corp" are actually forming an LLC with an S-Corp election — not incorporating as a traditional corporation.

When NOT to Elect S-Corp

The S-Corp election isn't right for everyone. Skip it if: your net SE income is below $60,000 (savings don't justify the costs), your income is highly variable and unpredictable (the payroll commitment adds complexity), you're planning to raise outside investment soon (S-Corps have strict ownership rules — one class of stock, no more than 100 shareholders, all must be U.S. individuals), you value simplicity above all else (sole proprietorship is dramatically simpler), or your state has high S-Corp fees (California's $800 minimum franchise tax, for example, eats into savings for lower-income filers).

How to Make the Election

If you decide an S-Corp election makes sense, the process is: form an LLC in your state (if you haven't already), file Form 2553 with the IRS to elect S-Corp tax treatment (this must be filed within 75 days of the start of the tax year you want the election to take effect, or at any time during the preceding tax year), set up payroll to pay yourself a reasonable salary, and work with a CPA to handle the initial setup and first-year filing.

This is one area where hiring a CPA pays for itself. The setup has enough nuance — reasonable salary determination, state-specific requirements, payroll registration, and the 2553 filing timeline — that professional guidance prevents expensive mistakes.