What an S-corp election actually does
An LLC's default federal tax treatment is sole proprietorship (single member) or partnership (multi-member). Owners pay self-employment tax — 15.3% — on net business income up to the Social Security wage base ($176,100 in 2025), then 2.9% (plus 0.9% Additional Medicare) above. Electing S-corp status splits income between W-2 wages (subject to FICA) and distributions (not subject to SE tax). The savings come from the distribution portion.
The simple math
Suppose your business nets $150,000. As a sole proprietor, SE tax is roughly $20,000. As an S-corp paying yourself $80,000 in reasonable wages and $70,000 in distributions, employer + employee FICA on $80k is roughly $12,000. Net SE-tax savings: about $8,000. Subtract payroll cost (~$600–$1,200/yr), additional bookkeeping, an entity return (Form 1120-S, ~$1,000–$2,500), and unemployment insurance ($300–$700). Net savings in this example: $4,000–$6,000.
When the math doesn't work
If your business nets less than ~$60,000–$80,000 over reasonable salary, the cost of payroll, accounting, and the additional return often exceeds the FICA savings. If your net is highly variable (consulting feast/famine), the rigidity of payroll can hurt cash flow. If you're a single-member LLC and don't actually take a meaningful distribution (everything goes back into the business), there's nothing to shelter.
Reasonable compensation: the IRS hot button
S-corp owners must pay themselves a 'reasonable' wage for the work they perform. Pay yourself too little and the IRS reclassifies distributions as wages with back-FICA, penalties, and interest. 'Reasonable' is fact-specific: what would the same role earn at a similar company in your market? We document with industry compensation data, role description, and hours — defensible if questioned.
Other tradeoffs
S-corp QBI deductions can differ from sole-proprietor QBI. Health-insurance premiums for >2% shareholders are deductible but must run through wages. Retirement contribution math changes (Solo 401(k) limits become a function of W-2 wages, not net SE income). State treatment varies — California charges a 1.5% S-corp tax with $800 minimum; Tennessee and Texas have entity-level taxes regardless. Each can swing the recommendation.
How to decide
Three questions: (1) Is your post-salary net consistently above ~$60k? (2) Are you willing to run payroll and a separate entity return? (3) Will your state's S-corp treatment hurt the savings? If yes-yes-not-much, the election usually pays. The cleanest path is to model your specific numbers — including state tax, retirement strategy, and health insurance — before filing Form 2553. We do that modeling as part of an S-corp evaluation.