S Corp vs LLC Taxes: Where the Saving Comes From, and Its Cost

An LLC's entire net profit is generally subject to self-employment tax on top of income tax. An S corporation splits that same profit into a reasonable salary, which carries employment tax like any wage, and a distribution, which does not. That single difference is the whole tax argument, and it produces a saving only once profit is large enough to cover the payroll, the extra return and the bookkeeping standard the split demands.

Everything else people attribute to the S election, liability protection, looking more legitimate, being able to have investors, is either untrue or belongs to the legal entity rather than the tax classification. If you have not separated those two things yet, start with LLC vs S corp vs C corp, because the S election is a tax choice made on top of an entity you already have.

What actually changes when an LLC elects S corporation taxation?

Nothing at the state level. Your LLC stays an LLC: same name, same operating agreement, same liability position, same contracts. What changes is how the IRS treats the money.

The row that people skip is the fourth. Income tax does not change. The S election moves employment tax, not income tax, and an owner expecting their total tax bill to fall by a third is going to be disappointed.

Where does the saving actually come from?

Take a business with profit of $150,000 after all expenses, where the owner does the work themselves.

As an LLC taxed by default, self-employment tax applies to essentially the whole $150,000, and the IRS explains that mechanism on its page on self-employment tax. With an S election and a reasonable salary of, say, $90,000, employment tax applies to the $90,000. The remaining $60,000 comes out as a distribution and carries income tax but not employment tax.

The size of the saving is that $60,000 multiplied by the current combined employment tax rate, less the extra costs below. This guide does not name that rate on purpose: it is statutory, the Social Security portion stops at a wage base that is adjusted every year, and an additional Medicare amount applies above an income threshold. Look up the current figures in IRS Publication 15 before you model anything, or read our companion piece on how payroll taxes are structured.

Two structural points matter more than the arithmetic. The saving scales with the gap between profit and salary, not with revenue, so a high-revenue low-margin business gets very little from it. And once the salary passes the Social Security wage base, the marginal saving on further distribution shrinks sharply, because only the uncapped Medicare portion is still in play.

What is reasonable compensation, and who decides it?

You do, and then the IRS gets to disagree. There is no formula and no safe percentage, despite the number of articles that quote one. The standard is what you would have to pay someone else to do the job you are doing, judged on training, duties, hours, what comparable businesses pay, and what the business can support. The IRS sets out its thinking on S corporation compensation and more generally on paying yourself.

Three things make a salary defensible: an actual basis you wrote down before you picked the number, consistency year to year, and a distribution that does not dwarf the salary to an implausible degree. Three things make it indefensible: a salary chosen because it was the smallest number that felt survivable, a salary that ignores that you also do sales and operations rather than only the technical work, and a salary that never moves while profit triples.

The consequence of getting it wrong is not a friendly adjustment. Distributions get recharacterised as wages, with back employment taxes, interest and penalties, across every open year.

What does the S election cost to run?

• Payroll. A real payroll cycle, with withholding, deposits on a schedule, quarterly filings and an annual W-2. Missing a deposit deadline carries penalties independently of whether you owed the money.
• A separate return. The S corporation files its own return and issues you a K-1. That is a second engagement with your preparer every year.
• A higher bookkeeping standard. The distinction between salary, distribution, loan and expense reimbursement has to be visible in the books. Casual owner draws, which are harmless in a default LLC, become a problem here.
• Basis tracking. Distributions in excess of your basis are taxable, and basis moves every year with profit, losses and distributions. Nobody tracks this by accident.
• Payroll in every state where you work, if that is more than one.

Together these commonly add several thousand dollars a year in professional fees and administration. That is the number the saving has to clear.

Where is the break-even?

There is no universal figure, and the ones you see quoted are rules of thumb rather than analysis. The break-even is where the employment tax saved on the distribution exceeds the added payroll, filing and bookkeeping cost, and it moves with four things you can actually check.

1. Profit after paying yourself properly, not revenue and not profit before a realistic salary.
2. How defensible a low salary is in your trade. A field with published salary data for your role leaves less room than one without.
3. What your accountant charges for the extra return and payroll, which varies more than the tax saved does.
4. Your state. Several states tax S corporations at the entity level, impose franchise or minimum taxes, or do not recognise the election at all, which can erase the federal benefit entirely.

The useful version of this question is not "what is the threshold" but "model my actual numbers both ways for the next two years". Any adviser who answers it with a national figure has not looked at your state.

Does an S corporation help or hurt the QBI deduction?

It can do either, which is why this deserves its own paragraph. The qualified business income deduction applies to pass-through profit, and an S corporation salary is a wage rather than pass-through profit, so paying yourself more salary reduces the income eligible for the deduction. That argues for a low salary.

Above certain income levels, however, the deduction is limited by reference to W-2 wages the business paid, which argues for a higher salary. The two pressures point in opposite directions and the crossover depends on your income, your industry and your filing status. The IRS form and instructions at Form 8995 are the starting point, and the thresholds involved are adjusted annually, so this is precisely the calculation not to do from memory or from an article.

What else does the salary number affect?

The employment tax saving is not free money, and three consequences are routinely ignored.

Social Security credits. Your future benefit is calculated on your earnings record. A low salary today lowers it.

Retirement contributions. Contributions to a solo 401(k) or SEP through an S corporation are generally computed on W-2 compensation. A low salary caps how much you can shelter, and that shelter is often worth more than the employment tax saved.

Borrowing. Mortgage and business lending underwriting looks at documented income. A minimal salary plus distributions is a harder file than a salary.

Who is actually equipped to run this?

An S corporation needs three services running together: bookkeeping good enough to support the split, payroll to pay the salary, and planning to set it. Of the 27,281 US accounting firms we profile from their own websites, 1,350 advertise all three. That is 4.9%.

And the gap that matters most: 8,975 of the 12,483 firms advertising tax preparation do not advertise tax planning, which is 71.9% of them. Preparation records what happened. The S election is a decision made before it happens, and a salary set once and never revisited is the most common way a well-intentioned election drifts into an indefensible one.

When should you not elect?

• Profit is modest. The costs land first and the saving arrives later.
• Your profit is volatile. A salary you cannot pay in a bad year is a problem, and the payroll obligations do not pause.
• You are not doing the work. If the profit comes from capital or from other people's labour rather than yours, the salary argument is weaker and the reasonable compensation analysis changes.
• You are about to raise money. The S election's ownership restrictions are incompatible with most institutional investors.
• You are already behind on your books. Elect after you fix that, not before.
• Your state neutralises it. Check before you file Form 2553, which also has timing rules that can push the effect into next year.

What to do next

Work out your profit after a salary you could defend to a stranger, get a quote for the extra return and payroll, and check how your state treats S corporations. If the saving does not clearly beat the cost with room to spare, wait a year: the election will still be available, and it is far cheaper to make late than to unwind.

Then take the model to someone who does planning rather than only preparation. CPAs near you and accountants near you list the services each firm advertises, so you can shortlist the firms that name tax planning and payroll before you spend a meeting finding out they do neither. For the deductions side of the same return, small business tax deductions covers what you can claim whichever way you are taxed.

Method and caveats

Directory figures come from the AccountingNearYou dataset as of 28 August 2026: 27,281 US accounting firms profiled from their own public websites, of which 12,483 advertise tax preparation, 5,559 advertise tax planning, 5,106 advertise payroll and 11,715 advertise bookkeeping. A firm counts only where the service appears on the pages we crawled, so these are counts of what firms advertise, not of everything they do. Firms that do planning without describing it separately from preparation are not in the 5,559.

The $150,000 and $90,000 in the worked example are illustrative placeholders, not a recommendation, and no tax rate, wage base or threshold appears anywhere in this guide. Employment tax rates, the Social Security wage base, the additional Medicare threshold and the qualified business income limits are all set by statute and adjusted, so confirm current figures against IRS guidance for your filing year. This is general information about how the S election works in the United States. It is not advice about your business, reasonable compensation is decided on your specific facts, and state treatment can reverse the answer entirely.