"Should I become an S-corp?" is one of the most common — and most misunderstood — questions small business owners ask. The short answer: an LLC and an S-corp are not really competing choices, because an S-corp is a tax election, not a business structure. Most owners keep their LLC and simply elect to be taxed as an S-corporation. Done at the right income level, that election can save thousands in self-employment tax every year. Done wrong, it invites an IRS audit. Here is how to think about it.
This is general information, not individual tax advice — the right choice depends on your specific numbers.
The Core Difference: How Your Profit Is Taxed
By default, a single-member LLC is taxed like a sole proprietorship: all of your net profit is subject to self-employment tax — 15.3% for Social Security and Medicare — on top of income tax. With an S-corp election, you split your income into two buckets: a reasonable salary (subject to payroll tax) and the remaining profit as a distribution (not subject to the 15.3% self-employment tax). That split is where the savings come from.
How the Election Actually Saves Money
Consider an owner with $150,000 of net profit. As a sole proprietor / default LLC, self-employment tax runs roughly $21,000–$23,000. Elect S-corp status, pay yourself a reasonable $70,000 salary, and take the remaining $80,000 as a distribution — and only the salary bears payroll tax. The self-employment/payroll tax falls to roughly $10,700, a difference on the order of $10,000 a year. The higher your profit above a reasonable salary, the larger the potential saving.
The Catch: "Reasonable Compensation"
You cannot simply pay yourself $1 and take everything as a distribution. The IRS requires S-corp owner-employees to take reasonable compensation — a salary that reflects what someone would be paid for the work you actually do. The IRS weighs your training and experience, duties, time devoted to the business, comparable industry pay, and the company's finances. Set the salary too low and the IRS can reclassify distributions as wages, then add back-taxes, penalties, and interest. This is one of the most audited areas for small corporations, so the salary figure deserves real, defensible support — not a guess.
The Costs (and the Break-Even)
The S-corp election isn't free. You'll run formal payroll, file a separate corporate return (Form 1120-S), and typically pay more in bookkeeping, payroll processing, and tax prep — often a few thousand dollars a year combined. Because of that overhead, the election usually only makes sense once profit is high enough to outweigh the cost — commonly around $60,000–$80,000 of net profit and up. Below that, the savings may not justify the complexity.
How to Make the Election
You keep your LLC and file Form 2553 with the IRS to be taxed as an S-corp. Timing matters: to apply for the current tax year, the election generally must be filed within 2 months and 15 days of the start of that year (by March 15 for calendar-year businesses), though late-election relief exists in many cases. Once elected, you must actually run payroll and stay compliant — the election is a commitment, not a checkbox.
How VarStan Helps
The S-corp decision is exactly the kind of question that pays to get right — the savings are real, but so are the compliance traps. As a CPA-led firm, we model the actual numbers for your business, determine a defensible reasonable salary, handle the Form 2553 election and ongoing payroll, and make sure the tax savings aren't eaten by penalties or overhead. If you're wondering whether an S-corp election would put money back in your pocket, that is a conversation worth having before the next filing deadline.