LLC or S-Corp: The Decision That Could Save You Thousands in Taxes
Choosing between an LLC and an S-Corp affects how much self-employment tax you pay every year. Here is what you need to know before you decide.
Not sure whether your business should be an LLC or an S-Corp? You are not alone. This is one of the most common questions I get from small business owners, and the answer matters more than most people think. The wrong structure can cost you thousands of dollars every year in taxes you did not have to pay.
Let me break this down in plain language.
What Is an LLC?
An LLC, or Limited Liability Company, is a legal structure that protects your personal assets if something goes wrong with your business. It is popular because it is simple to set up and flexible to run.
By default, a single-member LLC is taxed as a sole proprietorship. That means the IRS sees all the money your business makes as your personal income. You report it on Schedule C and you pay self-employment tax on all of it. In 2025, that self-employment tax rate is 15.3% on the first $176,100 of net earnings, and 2.9% above that.
So if your business nets $80,000, you owe about $11,300 in self-employment tax before you even get to income tax.
What Is an S-Corp?
An S-Corp is a tax election, not a separate business structure. You can have an LLC and elect to be taxed as an S-Corp by filing Form 2553 with the IRS.
Here is why this matters. With an S-Corp, you split your income into two parts: a reasonable salary you pay yourself as an employee, and a distribution from the business profits. You pay payroll taxes only on the salary, not on the distributions.
That difference is where the savings come from.
A Simple Example a 10-Year-Old Could Follow
Imagine your business is a lemonade stand that makes $80,000 a year.
If you are taxed as a regular LLC, you pay self-employment tax on the full $80,000. That is roughly $11,300 just in self-employment tax.
Now imagine you elect S-Corp status. You pay yourself a reasonable salary of $38,000 and take the remaining $42,000 as a distribution. You pay payroll taxes only on the $38,000 salary. That is about $5,370 in payroll taxes.
The difference is roughly $5,930 saved per year. That is money staying in your pocket instead of going to the IRS.
In real business situations where net profits are higher, the savings can reach $10,000 to $20,000 or more per year.
When Does an S-Corp Election Actually Make Sense?
The S-Corp election is not the right move for every business. There are real costs involved: payroll setup, quarterly payroll tax filings, a separate business tax return (Form 1120-S), and the requirement to pay yourself a “reasonable salary” that the IRS will scrutinize if it is too low.
Generally, the S-Corp election starts to make financial sense when your business is netting somewhere around $50,000 to $60,000 or more per year after expenses. Below that threshold, the administrative costs can eat into or erase the tax savings.
Here is a quick way to think about it:
- Net profit under $40,000: Stick with the LLC default. The savings are minimal and the extra cost and complexity is not worth it.
- Net profit between $40,000 and $60,000: It depends. Run the numbers. The savings may cover costs, but it is close.
- Net profit above $60,000: The S-Corp election is likely worth exploring seriously.
The “Reasonable Salary” Rule
One thing people get wrong about the S-Corp election: you cannot pay yourself a $1 salary to avoid all payroll taxes. The IRS requires that you pay yourself a reasonable salary for the work you do in the business.
What counts as reasonable? It should reflect what you would pay someone else to do your job. If you are a freelance graphic designer netting $90,000, paying yourself $25,000 in salary is probably not going to hold up to IRS scrutiny. Something closer to market rate is expected.
Getting this number right matters. Pay too little and you risk IRS penalties. Pay too much and you lose the benefit of the election.
California-Specific Considerations
If you are doing business in California, there is an additional factor. California charges a minimum $800 franchise tax on LLCs and corporations, including S-Corps. S-Corps in California also pay a 1.5% state tax on net income.
For California business owners, you need to factor these costs into the decision alongside the federal self-employment tax savings.