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

For self-employed individuals and small business owners, few tax decisions are more impactful than choosing between an LLC (Limited Liability Company) and an S-Corporation. Both structures offer liability protection and pass-through taxation — but they are taxed differently in one critical way that can be worth thousands of dollars per year once your income reaches a meaningful level.

The good news: this is not an either/or choice at the entity structure level. An LLC can elect S-Corp tax treatment without reorganizing as a separate entity. The question is really: "Should my business be taxed as a sole proprietorship/partnership, or should it elect S-Corp treatment?"

How Each Structure Is Taxed

LLC (default tax treatment): A single-member LLC is taxed as a sole proprietorship by default. All net profits are reported on Schedule C and are subject to self-employment tax at 15.3% on the first $176,100 (2025) and 2.9% above that — in addition to ordinary income tax on the full amount.

S-Corporation: An S-Corp allows you to split income between a "reasonable salary" (subject to payroll/self-employment taxes) and "distributions" (not subject to payroll taxes). Only the salary portion is hit with the 15.3% SE/payroll tax. The distribution portion is still taxed as ordinary income, but avoids the SE tax entirely.

The Math: Why S-Corp Saves Money

Suppose you have $150,000 in net business profit.

As a sole proprietor (LLC default): $150,000 × 15.3% SE tax (on first $176,100) ≈ $21,195 in SE tax, plus income tax on $150,000.

As an S-Corp with a $75,000 salary and $75,000 in distributions: payroll tax on $75,000 ≈ $11,475 (employer + employee), plus income tax on $150,000. The $75,000 distribution avoids SE tax entirely.

Approximate tax savings: $21,195 − $11,475 = ~$9,720 per year. The actual number varies with income, salary level, state taxes, and benefits, but the principle holds.

The Breakeven Point

The S-Corp election makes financial sense only when the tax savings exceed the additional costs. Those costs are real: payroll setup and processing ($50–$150/month), additional tax filings (Form 1120-S, quarterly payroll filings), payroll taxes and employer FICA match, and often higher CPA fees.

A rough rule of thumb: the S-Corp election typically breaks even at $50,000–$80,000 in net business profit and becomes increasingly valuable above that. Below that level, the administrative costs often exceed the tax savings.

What Counts as a "Reasonable Salary"

The IRS requires S-Corp shareholder-employees to pay themselves a "reasonable salary" for their services before taking distributions. This is intentional: if there were no salary requirement, every S-Corp owner would pay themselves $1 in salary and take all profits as distributions, eliminating payroll taxes entirely.

The IRS has successfully challenged unreasonably low S-Corp salaries in court, so this is not an area to be aggressive. A reasonable salary is generally benchmarked against what you would pay an unrelated employee to perform your work. Factors include: industry compensation data, hours worked, specific skills, geographic location, and the size and nature of the business.

Work with a CPA to determine an appropriate salary for your role. Paying yourself $30,000 when market compensation for your work is $120,000 is an audit risk. Paying yourself $80,000 out of $130,000 in profit is generally defensible.

Additional Considerations

Retirement plan contributions. Both LLCs and S-Corps can contribute to retirement plans. However, Solo 401(k) employee contribution limits in an S-Corp are based on W-2 wages, not total profit — so artificially low salaries limit your ability to contribute to retirement accounts. This is another reason not to minimize your salary too aggressively.

State treatment varies. Some states, including California, impose a separate tax or fee on S-Corps (California charges an $800 minimum franchise tax plus a 1.5% S-Corp tax). Your state tax picture matters and should be factored into the breakeven calculation.

Fringe benefits. S-Corp shareholder-employees who own more than 2% cannot take certain tax-free fringe benefits (like employer-sponsored health insurance) pre-tax. Health insurance premiums for 2%+ shareholders must be included in W-2 wages, though they are deductible on the personal return. This is administrative complexity worth planning around.

When to make the election. The S-Corp election can be made at any time — for a new business, at the start of any tax year, or even mid-year in some circumstances. Work with a CPA to time it correctly and ensure payroll systems are in place before the election is effective.