S‑Corp or Not? A Simple, Numbers-First Guide for Confused Founders

You’re forming an LLC.

But everyone’s talking about S-Corp elections. Should you elect? Will it save you money? When does it help? When does it hurt?

The answer depends on your numbers.

S-Corp elections can save taxes. But they add complexity. They work for some businesses. They don’t work for others.

This guide shows you when and why.

Real scenarios. Number comparisons. When S-Corp helps. When it doesn’t. How to decide.

Read this. Understand the numbers. Make the right decision.

What Is S-Corp

S-Corp is a tax election, not an entity type.

What it is:

• Tax election filed with the IRS
• Available to LLCs and Corporations
• Changes how your business is taxed
• Doesn’t change your legal structure

What it’s not:

• A separate entity type
• Required for LLCs or Corporations
• Always beneficial
• Simple to maintain

The reality: S-Corp is a tax election that can save money in the right circumstances. Understanding when it helps is key.

How S-Corp Works

S-Corp changes how you’re taxed.

Default LLC Taxation

How it works:

• LLC profits pass through to owners
• All profits subject to self-employment tax
• Self-employment tax rate: 15.3% (on income up to Social Security wage base)
• Income tax on all profits

Example:

• $100,000 profit
• $15,300 self-employment tax
• Plus income tax on $100,000

Why it matters: Default LLC taxation means all profits face self-employment tax.

S-Corp Taxation

How it works:

• You pay yourself a “reasonable salary”
• Salary is subject to payroll taxes (same as self-employment tax)
• Remaining profits are “distributions”
• Distributions are NOT subject to self-employment tax
• Income tax on all profits (salary + distributions)

Example:

• $100,000 profit
• $50,000 reasonable salary (payroll taxes apply)
• $50,000 distribution (no self-employment tax)
• Payroll taxes on $50,000 instead of $100,000

Why it matters: S-Corp can reduce self-employment taxes on distributions.

Pro tip: The tax savings come from avoiding self-employment tax on distributions. But you must pay yourself a reasonable salary first.

When S-Corp Helps

S-Corp works best in these situations:

High Profits Above Reasonable Salary

When it applies:

• Business has significant profits
• Profits exceed reasonable salary amount
• Large portion can be taken as distributions
• Tax savings exceed added costs

Example:

• $200,000 profit
• $80,000 reasonable salary
• $120,000 distribution
• Self-employment tax savings on $120,000

Why it matters: High profits create opportunity for significant tax savings.

Established Business with Consistent Profits

When it applies:

• Business is established and profitable
• Profits are consistent and predictable
• Can justify reasonable salary
• Can handle added compliance

Why it matters: Established businesses can better handle S-Corp complexity.

Multiple Owners

When it applies:

• Multiple owners sharing profits
• Each owner can take distributions
• Tax savings multiply across owners
• Compliance costs shared

Why it matters: Multiple owners can share compliance costs while each benefits from tax savings.

Pro tip: S-Corp works best when you have significant profits above a reasonable salary. The tax savings must exceed the added costs and complexity.

When S-Corp Hurts

S-Corp doesn’t make sense in these situations:

Low Profits or Losses

When it applies:

• Business has low profits
• Profits don’t exceed reasonable salary
• Business has losses
• No tax savings opportunity

Example:

• $40,000 profit
• $50,000 reasonable salary (can’t justify)
• No distribution opportunity
• Added compliance costs with no benefit

Why it matters: Low profits don’t create tax savings opportunity. Added costs aren’t worth it.

New or Unstable Business

When it applies:

• Business is new
• Profits are uncertain
• Can’t predict reasonable salary
• Compliance burden too high

Why it matters: New businesses may not have consistent profits to justify S-Corp.

Single Owner with Low Profits

When it applies:

• Single owner
• Profits barely exceed reasonable salary
• Small tax savings
• Compliance costs exceed savings

Why it matters: Small tax savings don’t justify added complexity and costs.

Pro tip: S-Corp doesn’t make sense when profits are low or uncertain. The added costs and complexity must be justified by tax savings.

Real Scenarios

Here are real-world examples:

Scenario 1: High-Profit Consulting Business

The situation:

• Solo consultant
• $150,000 annual profit
• Can justify $70,000 reasonable salary
• $80,000 available for distribution

Without S-Corp:

• Self-employment tax on $150,000
• Approximately $22,950 in self-employment tax

With S-Corp:

• Payroll taxes on $70,000 salary
• No self-employment tax on $80,000 distribution
• Approximately $10,710 in payroll taxes
• Tax savings: approximately $12,240

Verdict: S-Corp makes sense. Significant tax savings justify added costs.

Scenario 2: Low-Profit Service Business

The situation:

• Solo service provider
• $45,000 annual profit
• Can justify $40,000 reasonable salary
• $5,000 available for distribution

Without S-Corp:

• Self-employment tax on $45,000
• Approximately $6,885 in self-employment tax

With S-Corp:

• Payroll taxes on $40,000 salary
• No self-employment tax on $5,000 distribution
• Approximately $6,120 in payroll taxes
• Tax savings: approximately $765

Verdict: S-Corp may not make sense. Small tax savings may not justify added compliance costs.

Scenario 3: New Business with Uncertain Profits

The situation:

• New business
• First year operations
• Uncertain profit levels
• Can’t predict reasonable salary

Without S-Corp:

• Simple default LLC taxation
• No added compliance

With S-Corp:

• Must set up payroll
• Must determine reasonable salary
• Added compliance from day one
• May not have profits to justify

Verdict: Wait until business is established. S-Corp can be elected later when profits are clear.

Pro tip: Calculate your specific numbers. Compare tax savings to added costs. Make decision based on your situation.

S-Corp Requirements

S-Corp elections have specific requirements.

Eligibility Requirements

What’s required:

• Must be domestic entity (LLC or Corporation)
• Must have 100 or fewer shareholders
• Shareholders must be individuals, certain trusts, or estates
• Only one class of stock allowed
• Must not be an ineligible corporation (insurance, financial institution, etc.)

Why it matters: Not all businesses are eligible for S-Corp election.

Reasonable Compensation

What’s required:

• Must pay yourself reasonable salary
• Salary must reflect fair market value
• IRS can challenge unreasonable salaries
• Must pay payroll taxes on salary

Why it matters: Reasonable compensation is required. Too low risks IRS challenge.

Payroll Processing

What’s required:

• Must process payroll for salary
• Must withhold and pay payroll taxes
• Must file payroll tax returns
• Must issue W-2 forms

Why it matters: Payroll processing adds cost and complexity.

Additional Tax Filings

What’s required:

• Must file Form 1120-S (S-Corp tax return)
• Must file K-1 forms for each owner
• More complex than default LLC taxation

Why it matters: Additional filings add cost and complexity.

Pro tip: S-Corp requirements add significant compliance burden. Make sure tax savings justify the added work. See our compliance guide for entity requirements.

How to Decide

Use this framework to decide:

Step 1: Calculate Your Profits

What to do:

• Estimate annual business profits
• Be realistic and conservative
• Consider growth potential

Why it matters: Profits determine tax savings opportunity.

Step 2: Determine Reasonable Salary

What to do:

• Research fair market salary for your role
• Consider your industry and experience
• Be conservative in estimates
• Ensure salary is defensible

Why it matters: Reasonable salary determines distribution opportunity.

Step 3: Calculate Potential Tax Savings

What to do:

• Calculate self-employment tax on all profits (without S-Corp)
• Calculate payroll taxes on salary + no tax on distributions (with S-Corp)
• Compare the difference
• This is your potential tax savings

Why it matters: Tax savings must justify added costs.

Step 4: Estimate Added Costs

What to do:

• Payroll processing costs
• Additional tax preparation costs
• Time and complexity costs
• Total added costs

Why it matters: Added costs reduce net benefit.

Step 5: Make the Decision

What to consider:

• Tax savings vs. added costs
• Your ability to handle compliance
• Business stability and profit consistency
• Growth potential

Decision rule: Elect S-Corp if tax savings significantly exceed added costs and you can handle compliance.

Pro tip: Consult with a tax professional for your specific situation. They can help you calculate exact numbers and make the right decision. See our entity type decision tree for broader entity selection guidance.

Your Next Steps

Understand the numbers. Calculate your situation. Make the right decision.

This Week:

1. Review this guide
2. Estimate your business profits
3. Research reasonable salary for your role
4. Calculate potential tax savings

This Month:

1. Compare tax savings to added costs
2. Consult with tax professional if needed
3. Make S-Corp election decision
4. File election if beneficial (Form 2553)

Going Forward:

1. Monitor your business profits
2. Reassess S-Corp election annually
3. Adjust salary as business grows
4. Maintain compliance requirements

Need help? Check out our entity type decision tree for broader entity selection, our compliance guide for entity requirements, and our LLC formation guide for detailed formation information.

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