Somewhere on the internet right now, someone is telling a business owner that an S-corp election will change their life. Sometimes it's true. The rest of the time it adds cost and paperwork for savings that never materialize. The difference is arithmetic, not opinion.
What the election actually changes
A single-member LLC's entire profit is subject to self-employment tax — roughly 15.3% on the first tranche of income — on top of income tax. An S-corp splits your take into salary (which pays payroll taxes) and distributions (which don't). The savings live entirely in that split.
What it costs
The election isn't free: you'll run real payroll (software, filings, possibly our payroll service), file a separate 1120-S return, and in some states pay entity-level fees or franchise taxes. Realistic all-in cost: a few thousand dollars a year.
The "reasonable compensation" catch
You can't pay yourself $20,000 and distribute $200,000 — the IRS requires salary that's reasonable for your role, industry, and hours, and it audits this. The honest analysis prices your job first, then asks whether meaningful profit remains above it. If not, the election has nothing to work with.
When the LLC wins
Below the break-even, in high-fee states, in loss years, and in businesses whose income is mostly returns on capital rather than the owner's labor, the default LLC keeps things simpler and often cheaper. There's no shame in the boring answer.
The good news: it's reversible sequencing
An LLC can elect S-corp treatment later with a form — so the smart path is usually: form the LLC, keep clean books, and make the election in the first year the math clearly works. We run that analysis in every formation engagement, and re-run it as clients grow.
Running the break-even yourself
The arithmetic is straightforward. Start with net profit before any owner compensation. Subtract a defensible salary for the work you personally do — what you would pay someone else to do your job in your market. What remains is the distribution portion, and roughly 15.3% of it (less above the Social Security wage base) is the self-employment tax you avoid.
Then subtract the real cost of the election: payroll processing, the separate 1120-S return, state entity-level fees, and the additional bookkeeping. If the savings do not clear that cost with room to spare, the election is noise.
A worked example: $180,000 of profit with a defensible $95,000 salary leaves $85,000 of distributions, saving roughly $13,000 in self-employment tax against maybe $3,000–4,000 of added cost. Clearly worth it. At $95,000 of profit with the same salary, there is almost nothing left to shelter.
State-level costs change the answer
California charges an $800 minimum franchise tax plus a 1.5% tax on S corporation net income, which meaningfully raises the break-even. Oregon and Georgia are friendlier, and the pass-through entity elections available in all three states interact with the decision — sometimes making the S corporation more attractive, sometimes less.
This is why national rules of thumb mislead. The same profit produces a different answer in Ontario than in Salem or Savannah.
What else the election affects
QBI deduction. Paying yourself a salary reduces QBI but W-2 wages can also increase the deduction limit at higher incomes. The interaction is real and worth modeling.
Retirement plan capacity. Employer contributions key off W-2 wages, so a very low salary can shrink the retirement plan you are allowed to fund — occasionally costing more than the payroll tax saved.
Loan applications and PPP-style programs. Lenders read the salary line. An artificially low salary can complicate borrowing.
Multiple owners. S corporations have shareholder eligibility limits and require pro-rata distributions, which can be a genuine constraint where an LLC operating agreement would allow flexibility.
Questions we get on entity choice
Can we elect S-corp treatment mid-year or retroactively?
There is a filing deadline for the election to apply to the current year, and late-election relief exists in some circumstances. The cleanest path is to decide before the year starts, or early in it.
What is a defensible salary?
One supported by what the role would cost in your market for your hours and duties, documented with comparables. There is no safe-harbor percentage, and the IRS audits this — so the file matters as much as the number.
Does an S-corp reduce audit risk?
No. It changes the return you file and adds payroll compliance. What reduces risk is documentation — reasonable compensation support, clean books, and consistent treatment year to year.