LLC vs S-Corp Tax Comparison
LLC and S-Corp are the two most common business structures for small businesses in the US. Both offer liability protection, but they differ significantly in how taxes work. This guide compares tax treatment, salary requirements, deductions, and total tax savings for each structure.
Quick Overview Table
| Factor | LLC (Default Tax Treatment) | S-Corporation |
|---|---|---|
| Self-employment tax | 15.3% on ALL net income | 15.3% on salary only; distributions free from SE tax |
| Salary requirement | No salary required (owner draws) | Must pay "reasonable salary" (IRS rule) |
| Profit distribution | All profit is owner income (Schedule C) | Profit splits into salary + distributions |
| Tax filing | Schedule C with personal return (Form 1040) | Form 1120-S corporate return + K-1 to owner |
| Setup complexity | Low — simple formation, few ongoing requirements | Moderate — requires payroll, quarterly filings, annual meeting |
| State-level considerations | Simpler in most states | Some states (California, NY, Texas) charge franchise tax |
The Self-Employment Tax Advantage of S-Corp
The biggest tax difference is self-employment tax. As an LLC owner, you pay 15.3% SE tax on all business income. With an S-Corp, you split income into two parts:
- Salary — Subject to 15.3% SE tax (both employee and employer portions)
- Distributions — Free from SE tax entirely
Example: $100,000 profit. LLC = $15,300 SE tax. S-Corp with $50,000 salary = $7,650 SE tax + ~$1,000 in payroll/admin costs = ~$8,650. Net savings: ~$6,650/year.
The savings increase with profit. At $50K profit, the savings are minimal. At $200K profit, savings can exceed $15K/year.
Rule of Thumb: When to Switch to S-Corp
Most tax professionals recommend considering S-Corp election when your net profit exceeds $60,000-$80,000/year. Below that, the added complexity and costs (payroll, filing fees, accountant) often outweigh the tax savings.
At $100K+ profit, S-Corp almost always saves money. At $150K+, the savings are substantial.
Reasonable Salary Rules
The IRS requires S-Corp owner-employees to pay themselves a "reasonable salary" — what you'd pay someone else to do your job. Setting salary too low (and taking more tax-free distributions) is a red flag for audit. The IRS has won cases against owners who set unreasonably low salaries.
Industry benchmarks can help determine reasonable salary. A common guideline is 40-60% of net profit as salary, but this varies by industry and role.
Other Tax Differences
Costs of S-Corp (Why It's Not Free Money)
- Payroll processing — $500-$2,000/year for payroll service + filings
- Additional tax return — Form 1120-S corporate return ($500-$1,500 extra from CPA)
- Payroll tax filings — Quarterly 941, annual 940, state unemployment insurance
- State fees — Some states charge franchise tax for S-Corps (California: 1.5% on net income, minimum $800)
- Annual meetings & minutes — Required corporate formalities
Total additional costs: $1,500-$3,500/year. Factor this into your savings calculation.
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Frequently Asked Questions
Can I convert my LLC to an S-Corp?
Yes. File Form 2553 with the IRS to elect S-Corp status. You must be a domestic LLC, have only one class of stock, and have 100 or fewer shareholders. The election must be filed by March 15 of the tax year it should take effect.
Does S-Corp save money at every income level?
No. Below ~$60K profit, the payroll costs and filing fees often outweigh SE tax savings. The breakeven point varies by state and specific circumstances. Use the hard rule: if your profit is below $60K, stick with LLC.
What happens if the IRS says my S-Corp salary is too low?
The IRS can reclassify some distributions as wages, assess back payroll taxes, and charge penalties. To stay safe: document how you determined reasonable salary (industry data, comparable roles), and keep records of hours worked and duties performed.
Is LCC or S-Corp better for a freelancer?
For most freelancers earning under $80K, a single-member LLC is simplest and cheapest. Above $80K, S-Corp usually offers meaningful SE tax savings. If you're a 1099 contractor, use our 1099 Tax Calculator to estimate your tax burden under both structures.
Can I be an S-Corp and still use 1099 contractors?
Yes. An S-Corp can have employees AND contractors. You must pay yourself a W-2 salary, but you can still work with 1099 contractors. Just follow the same classification rules (control, independence, etc.) as any business.