LLC vs S-Corp: Choosing the Right Structure for a Small Business

Clearing up the vocabulary

An LLC is formed under state law and protects your personal assets. By default a single-member LLC is taxed as a sole proprietorship (Schedule C) and a multi-member LLC as a partnership (Form 1065).

An S-corporation is not a type of entity. It is a tax election (Form 2553) that an LLC or corporation can make. So the real comparison is: LLC taxed as default versus LLC taxed as an S-corp.

Where the savings come from

Under default taxation, all net profit is subject to 15.3% self-employment tax. Under an S-election, you pay yourself a reasonable salary (subject to payroll tax) and take the remaining profit as a distribution (not subject to SE tax).

Example: $120,000 profit. Default: SE tax ≈ $17,000. S-corp with $70,000 salary: payroll tax ≈ $10,700. Savings ≈ $6,300 before the extra costs below.

The costs of an S-corp

• Payroll service and filings (941, W-2, state unemployment): roughly $600–$1,200 a year
• A separate business return (Form 1120-S): typically $650+
• State fees: California charges a 1.5% franchise tax on S-corp income, for example
• Less flexibility on retirement contributions at lower salaries

The break-even

For most service businesses the election pays off once net profit is consistently above $60,000–$80,000. Below that, the fixed costs eat the savings.

Reasonable compensation

The IRS expects your salary to reflect what you would pay someone else to do your job. Paying yourself $20,000 on $200,000 of profit invites reclassification. We benchmark salaries against industry data.

Timing the election

Form 2553 is due within 2 months and 15 days of the start of the tax year you want it to apply to, which is March 15 for calendar-year businesses. Late elections are often accepted with a reasonable-cause statement, but do not count on it.

When to stay default

Profit under the break-even, a business you plan to close soon, or significant passive income (S-corps have limits): in those cases simplicity wins.

When a C-corp makes sense

Raising venture capital, retaining significant profit in the business, or planning to sell qualified small business stock (QSBS). For most owner-operators it does not.