S-Corp vs LLC: Which Is Right for Your Small Business?

"Should I be an LLC or an S-Corp?" is one of the most common — and most misunderstood — questions in small business. The short answer: they're not even the same kind of thing. One's a legal structure, the other's a tax election. Here's the actual tradeoff, the income threshold where it starts to matter, and how to decide without paying a CPA to confuse you about it.

First — they're different categories of thing

Most "LLC vs S-Corp" debates are misframed. An LLC is a legal entity — you form it with your state, and it gives you liability protection. An S-Corp is a tax election — you file a form with the IRS to be taxed in a specific way. You can have both: an LLC that has elected S-Corp tax treatment. That's actually the most common setup once a business gets large enough to benefit.

So the real question isn't "LLC or S-Corp" — it's "Should my LLC elect to be taxed as an S-Corp?"

How a default LLC is taxed

By default, a single-member LLC is taxed as a sole proprietorship (a multi-member LLC is taxed as a partnership). All net profit flows to your personal tax return — and you pay self-employment tax (15.3%) on every dollar of it. That's Social Security + Medicare taxes on top of regular federal income tax.

If your LLC nets $80,000, you owe self-employment tax on the full $80,000 — roughly $12,240 — before you even start on federal income tax.

How an S-Corp election changes the math

When you elect S-Corp tax treatment, the IRS treats you as an employee of your own business. You pay yourself a "reasonable salary" via payroll, and the salary is the only thing that gets hit with payroll taxes (the equivalent of self-employment tax, just split between employer and employee sides of the same coin). Profits above your salary flow through as distributions, which are not subject to self-employment tax.

Same $80,000-net business under S-Corp treatment: pay yourself, say, $50,000 in salary, take $30,000 as a distribution. Payroll taxes hit the $50,000 (~$7,650). The other $30,000 escapes self-employment tax entirely. Savings: roughly $4,500/year in this example.

The income threshold where it actually pays off

S-Corp election creates real overhead:

• Payroll service: $40–$80/month (Gusto, etc.)
• Separate corporate tax return (1120-S): usually $500–$1,500/year from a CPA
• Bookkeeping complexity: tracking salary vs distributions, shareholder basis, payroll reconciliations
• State franchise/excise taxes in some states (not SC)

Total drag is usually $1,500–$3,000 a year minimum. So an S-Corp election only makes sense if the self-employment tax savings exceed that. The rough rule of thumb:

• Under $40,000 net: stay default LLC. Overhead eats any savings.
• $40,000–$60,000 net: usually breakeven. Run actual numbers with your CPA.
• $60,000–$100,000 net: S-Corp typically saves $2,500–$5,000/year after overhead.
• $100,000+ net: S-Corp election almost always wins. Savings scale with income.

The "reasonable salary" rule — don't get cute

The S-Corp savings come from paying yourself a lower salary and taking the rest as distributions — and this is exactly where the IRS pays attention. Your salary has to be "reasonable" — what someone in your role would actually earn doing the same work for someone else.

Owners who try to pay themselves a $20,000 salary on $200,000 of net profit get flagged. The IRS can reclassify distributions as wages, hit you with back payroll taxes plus penalties, and the audit unravels into something much bigger than the savings ever were. We wrote a dedicated piece on reasonable compensation for S-Corp owners that walks through how the IRS calculates it and what defensible salary numbers actually look like.

Other tradeoffs that matter

Beyond the tax math, a few practical considerations:

• Retirement contributions. S-Corp owners can contribute to a Solo 401(k) or SEP-IRA based on W-2 wages, not net profit. Lower salary = lower retirement contribution room. Worth modeling before deciding.
• Health insurance. Owner health insurance has slightly different tax treatment under S-Corp (must be on W-2). Not a deal-breaker, but a step to plan for.
• Owners with multiple businesses. If you operate several entities, S-Corp election on each can compound complexity fast.
• Real estate / rental income. Rental income usually isn't subject to self-employment tax anyway, so S-Corp election typically doesn't help — and can complicate things. Real estate investors usually stick with default LLC.

When to file the election

To be taxed as an S-Corp for the current year, you generally need to file Form 2553 with the IRS by March 15 (within 75 days of the year start). Miss that deadline and you typically can't elect S-Corp treatment until the following tax year, though there are "late election relief" procedures if you qualify. If you're already mid-year and weighing this, talk to your CPA in October–December for next-year planning.

What this means for bookkeeping

S-Corp election noticeably raises the bar on your bookkeeping. You need:

• Clean monthly payroll reconciliation (W-2 owner salary tied out to actual payroll runs)
• Separate tracking of distributions (these come out of equity, not expense)
• Shareholder basis tracking (important for tax planning and audit defense)
• A balance sheet that reconciles — most CPAs require this for an 1120-S filing

This is exactly the kind of complexity that turns DIY books into a year-end mess. If you're considering S-Corp election or already have it, monthly bookkeeping that runs through payroll and equity properly isn't optional. Our monthly bookkeeping service handles all of this; if your books are already behind, catch-up bookkeeping gets you current before tax season.

The bottom line

Default LLC is the right answer for most businesses under about $60K of net profit. Above that, S-Corp election starts saving real money, and above $100K it's almost always the right call. But the savings only work if your bookkeeping and payroll are clean, your salary is defensibly reasonable, and you're prepared to pay for the additional tax return. Run actual numbers — don't just pattern-match what your friend did with a different business. The right structure pays for itself many times over; the wrong one costs you in audits, penalties, and unnecessary overhead.