If you run a profitable single-member LLC or sole proprietorship, every dollar of net profit is exposed to self-employment tax — 15.3% on earnings up to the Social Security wage base, then 2.9% (plus the 0.9% additional Medicare tax at higher incomes) on everything above it. That is on top of regular income tax. The S-corporation election is the most common tool for trimming that bill, and also the one most often done wrong.
How the savings actually work
When your LLC elects to be taxed as an S-corp, you become both an owner and an employee. You pay yourself a reasonable salary through payroll — that salary is subject to Social Security and Medicare taxes. The remaining profit is taken as a distribution, which is not subject to self-employment or payroll tax. The spread between your salary and your total profit is where the savings live.
A simplified example: a consultant nets $200,000. As a sole proprietor, most of that is hit with SE tax. As an S-corp paying a $90,000 salary, only the $90,000 carries payroll tax; the other $110,000 is distributed without it. The savings can run into five figures a year.
The catch: "reasonable" is not optional
The IRS knows this math too. Paying yourself an artificially low salary to shift more into distributions is one of the most reliable audit triggers for small S-corps. "Reasonable compensation" means what you would have to pay someone else to do your job — judged on your role, experience, hours, and what comparable professionals earn. There is no magic percentage, despite what you may read online.
Costs that eat into the benefit
- Running real payroll — filings, withholding, W-2s — which usually means a payroll provider.
- A separate business return (Form 1120-S) every year, with its own preparation cost.
- State-level friction. California, for example, charges a 1.5% franchise tax on S-corp net income and an $800 annual minimum.
- Interaction with the QBI deduction — wages reduce the income eligible for the 20% pass-through deduction, which can offset part of the payroll-tax savings for some owners.
A rough rule of thumb
For many service businesses, the election starts to make sense once net profit is consistently above roughly $80,000–$100,000 — enough that the SE-tax savings clear the added payroll and compliance cost. But it is genuinely facts-specific: your state, your reasonable salary, your retirement-plan strategy, and your QBI position all move the answer.
The bottom line: the S-corp savings are real, but so are the rules. A salary set too low to save tax is among the first things an examiner looks at. Model the numbers — and a defensible salary — before you file the election, not after.
This article is general information, not tax, legal, or accounting advice, and reading it does not create a CPA-client relationship. Tax rules change and depend on your specific facts — please consult a qualified professional about your situation before acting.