Why “S corp vs LLC” is really a question about taxes, and how to tell when an S corporation election could save you money.
Quick answer: An LLC is a type of legal business entity created under state law. An S corporation is a federal tax status that a corporation or an LLC can elect by filing IRS Form 2553. So you can have an LLC taxed as an S corp. The main reason owners elect S corp status is to reduce self-employment tax by paying themselves a reasonable salary and taking the rest of the profit as distributions, but it adds payroll and filing costs.
Many owners ask whether they should form an S corp or an LLC, as if they were two competing boxes. In reality, they answer different questions. An LLC is about legal structure and liability. An S corporation is about how the IRS taxes your business.
Understanding that difference makes the decision much easier. This guide explains how each works, compares the taxes with a worked example, and lists the rules you must meet to elect S corp status. It is general information, not tax advice, so check your numbers with an accountant.
In this article
- What is the difference between an S corp and an LLC?
- How is a default LLC taxed?
- How does S corp taxation work?
- Who can elect S corp status?
- When does an S corp election make sense?
- What counts as a reasonable salary?
- What are the risks and downsides?
- Frequently asked questions
- Final thoughts
What is the difference between an S corp and an LLC?
| LLC (default tax) | LLC or corporation taxed as an S corp | |
|---|---|---|
| What it is | A legal entity formed with your state | A federal tax election |
| How you create it | File articles of organization | File IRS Form 2553 |
| How profits are taxed | Pass-through to owners | Pass-through to owners |
| Self-employment tax | Usually on all profit | Only on owner salary, not distributions |
| Payroll required | No | Yes, for working owners |
| Ownership limits | None | Up to 100 shareholders, one class of stock |
Both pass profits through to your personal return. The key difference is how much of that profit is subject to Social Security and Medicare taxes.
How is a default LLC taxed?
The IRS taxes a single-member LLC like a sole proprietorship and a multi-member LLC like a partnership. Members generally pay income tax plus self-employment tax, at 15.3% up to the Social Security wage limit, on their share of the profit. Read our guide to the LLC meaning for the basics.
How does S corp taxation work?
According to the IRS S corporations page, an S corporation passes income, losses, deductions and credits through to its shareholders, who report them on their personal returns. The company files Form 1120-S and issues each owner a Schedule K-1.
Owners who work in the business must be paid a reasonable salary through payroll. That salary is subject to payroll taxes. Profit paid out above the salary as distributions is not subject to self-employment tax.
Sara’s LLC earns $100,000 in profit. As a default LLC, about all of it is subject to self-employment tax. After electing S corp status, she pays herself a reasonable $60,000 salary through payroll and takes $40,000 as distributions. Payroll taxes apply to the $60,000, not the $40,000. Her savings must then be weighed against payroll service fees, an extra tax return and accounting costs.
Who can elect S corp status?
The IRS lists these requirements:
- Be a domestic corporation or an LLC that elects to be taxed as one.
- Have only allowable shareholders, such as individuals, certain trusts and estates, and not partnerships, corporations or nonresident aliens.
- Have no more than 100 shareholders.
- Have only one class of stock.
- Not be an ineligible corporation, such as certain banks and insurance companies.
To elect, all shareholders sign Form 2553. Timing matters, so check the filing deadline in the instructions for the tax year you want the election to start.
When does an S corp election make sense?
- Steady, healthy profit: Savings usually only outweigh the extra costs once profit is well above a reasonable salary.
- You work in the business: The salary and distribution split is what creates the saving.
- You can handle payroll: You need to run payroll, file payroll tax returns and keep clean books.
- You meet the ownership rules: No more than 100 eligible shareholders and one class of stock.
Ask your accountant to model three numbers: your profit, a reasonable salary for your role, and the yearly cost of payroll and extra filings. If the payroll tax saving does not clearly beat those costs, stay a default LLC for now and review it next year.
What counts as a reasonable salary?
The IRS does not publish a fixed salary for each job. Instead, it expects S corp owners who work in the business to pay themselves what similar businesses would pay someone for the same work. Factors include your role, hours, experience and what comparable roles pay locally.
- Use market data: Look at salary surveys or job listings for similar roles in your area.
- Document your reasoning: Keep a short note explaining how you chose the figure.
- Review it each year: Adjust as the business and your role change.
Setting a fair, documented salary protects the tax benefit and reduces the risk of penalties if the IRS ever questions it.
What are the risks and downsides?
- Reasonable salary scrutiny: Paying yourself too little salary to avoid payroll taxes can draw IRS attention.
- More paperwork: Payroll, Form 1120-S, K-1s and possibly state filings.
- State rules vary: Some states tax S corporations differently or charge extra fees.
- Less flexibility: Profit must generally be shared in line with ownership, and the one class of stock rule limits investor deals.
A consultant elected S corp status in her first year with only $30,000 of profit. After paying for payroll software and an extra tax return, she saved almost nothing. She would have done better to wait until her profit grew.
Look at last year’s profit from your business. If it is modest or irregular, a default LLC is probably simpler. If it is steady and well above what you would pay yourself as a salary, book a session with an accountant to run the S corp numbers.
Frequently asked questions
Is an S corp better than an LLC?
Neither is always better. An LLC is a legal structure, and an S corp is a tax election that an LLC can choose. The election helps some owners with steady profits.
Can an LLC be an S corp?
Yes. An LLC can elect to be taxed as an S corporation by filing Form 2553, if it meets the IRS requirements.
What is the main advantage of an S corp?
Owners can reduce self-employment tax by taking part of their profit as distributions instead of salary.
Do I have to pay myself a salary in an S corp?
Yes, if you work in the business. The IRS expects a reasonable salary for the work you do.
How many owners can an S corp have?
Up to 100 shareholders, and they must be eligible types such as US individuals.
When should I switch my LLC to an S corp?
Usually once your profit is steady and high enough that the tax saving clearly outweighs the extra payroll and filing costs.
Final Thoughts
- An LLC is a legal entity, while an S corp is a federal tax election.
- An LLC can elect S corp taxation by filing Form 2553.
- The main benefit is lower self-employment tax on distributions.
- Weigh the savings against payroll, filing and accounting costs before electing.
