If you’re a small business owner, freelancer, or entrepreneur looking to minimize your tax burden, you’ve likely come across the terms LLC and S-Corp. While both offer liability protection and flexible business structures, their tax implications can differ significantly. Choosing the right one could potentially save you thousands of dollars in taxes each year.
In this comprehensive guide, we’ll break down the key differences between an LLC and an S-Corp, focusing specifically on tax savings. Whether you’re just starting a business or thinking of restructuring, understanding these distinctions is essential for making an informed decision.
What Is an LLC?
Definition
A Limited Liability Company (LLC) is a legal business entity that separates personal assets from business liabilities. It offers flexible management, less administrative burden compared to corporations, and protects your personal finances if your business faces debts or lawsuits.
How LLCs Are Taxed
By default, LLCs are considered “pass-through” entities:
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Single-member LLCs are taxed like sole proprietorships.
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Multi-member LLCs are taxed like partnerships.
All business income “passes through” to the owner(s) and is reported on personal income tax returns. However, all profits—regardless of whether they are distributed or reinvested—are subject to self-employment tax (Social Security and Medicare).
What Is an S-Corp?
Definition
An S-Corporation (S-Corp) is not a business structure like an LLC; it’s a tax classification that a business entity (typically an LLC or C-Corp) can elect by filing Form 2553 with the IRS.
How S-Corps Are Taxed
S-Corps also benefit from pass-through taxation, but with a critical tax-saving advantage:
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Owners must be paid a reasonable salary.
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Any remaining profit after salary can be distributed as dividends, which are not subject to self-employment tax.
This separation of salary and profit opens the door to significant tax savings.
LLC vs. S-Corp: Side-by-Side Tax Comparison
| Feature | LLC (Default) | LLC (with S-Corp Election) |
|---|---|---|
| Taxation | Pass-through | Pass-through |
| Self-Employment Tax | On 100% of profits | Only on owner salary |
| Salary Required? | No | Yes |
| Dividend Distributions | Not applicable | Taxed at lower rate, no SE tax |
| IRS Forms | Schedule C | 1120S, Schedule K-1, W-2 |
| Audit Risk | Lower | Slightly higher (due to salary scrutiny) |
Tax Savings with an S-Corp: A Simple Example
Let’s assume your business earns $100,000 in profit:
As an LLC:
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All $100,000 is subject to 15.3% self-employment tax = $15,300
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Total tax burden = $15,300 + income tax
As an S-Corp:
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Pay yourself a reasonable salary: $60,000
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SE tax = $60,000 x 15.3% = $9,180
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Distribute the remaining $40,000 as dividends
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No SE tax
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Total SE tax = $9,180
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Savings = $15,300 – $9,180 = $6,120
Note: This simplified example doesn’t include additional state or payroll taxes, but it demonstrates how S-Corp election can significantly reduce your tax liability.
When an S-Corp Makes Sense
While the tax savings are appealing, not every business will benefit from S-Corp election. Consider the following factors:
Profit Threshold
If your business makes over $40,000–$60,000 in annual profit, you might start seeing meaningful tax savings.
Ability to Pay a Reasonable Salary
The IRS requires that owners who perform services for the business take a salary that reflects market value for their work. Failing to do so could trigger audits or penalties.
Willingness to Handle Payroll
You’ll need to run payroll, issue W-2s, and file quarterly payroll taxes—this means hiring a bookkeeper or using payroll software.
Costs and Compliance: What to Expect
| Category | LLC | S-Corp |
|---|---|---|
| State Filing Fees | Yes | Yes |
| Payroll Processing | Not required | Required |
| Annual Reports | Varies by state | Varies by state |
| Accounting Complexity | Simple | Moderate to complex |
| Tax Filing | Schedule C (simpler) | Form 1120S, W-2, K-1 (complex) |
How to Elect S-Corp Status for Your LLC
If you decide to switch to an S-Corp, here’s how the process works:
1. Form Your LLC
Start by registering your business as an LLC with your state.
2. Apply for an EIN
Get an Employer Identification Number (EIN) from the IRS.
3. File Form 2553
Submit Form 2553 to the IRS to elect S-Corp status. You must file:
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Within 75 days of forming your LLC, or
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Within 75 days of the beginning of the tax year you want the S-Corp status to apply
4. Set Up Payroll
Use a payroll service to manage taxes, filings, and W-2 forms.
5. Stay Compliant
Keep meeting S-Corp requirements: annual meetings, issuing stock (if applicable), filing reports, and maintaining proper bookkeeping.
LLC vs. S-Corp by Business Type
Here’s how the decision plays out for various business owners:
Freelancers & Consultants
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If your profit is modest and you don’t want added complexity, an LLC may suffice.
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If you’re scaling up, consider S-Corp once profits exceed ~$60K.
E-Commerce Sellers
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S-Corp can be beneficial for those who generate consistent profits and want to minimize SE taxes.
Agencies & Service Providers
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S-Corp is ideal for owners working in the business who can justify reasonable salaries and benefit from dividends.
Real Estate Investors
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Generally, S-Corp isn’t recommended. Real estate income typically benefits more from LLCs and other tax strategies.
FAQs
Is an S-Corp better for tax savings than an LLC?
Yes, if your business earns enough profit, S-Corp status can reduce self-employment taxes by allowing part of your income to be distributed as dividends.
Can a single-member LLC elect to be taxed as an S-Corp?
Absolutely. Many single-member LLCs elect S-Corp status once their income justifies the switch.
What is considered a “reasonable salary”?
There’s no hard rule. It depends on your industry, role, and comparable market rates. The IRS wants you to pay yourself a salary similar to what you’d earn doing the same work elsewhere.
Can I switch back from S-Corp to LLC?
Yes, but it requires IRS approval and might involve tax consequences. Consult a CPA before making the change.
Does an S-Corp save on income taxes too?
Not directly. It saves primarily on self-employment taxes. However, certain state taxes and deductions (like QBI) may amplify your savings.
Conclusion: Which One Should You Choose?
Choosing between an LLC and an S-Corp comes down to your business’s income, growth plans, and willingness to manage compliance.
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Stick with a default LLC if you’re starting out, have lower profits, or prefer simplicity.
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Elect S-Corp status if you:
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Earn $60,000+ in net profit
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Can handle the added payroll and tax filing responsibilities
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Want to reduce your self-employment tax burden
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Ultimately, the decision can have a major impact on your bottom line. Before making the switch, consult a tax professional or accountant who understands your specific business situation.
I am a content writer with 5 years of experience and a degree in English Literature. Specializing in lifestyle, food, and health, she creates engaging, research-driven content.
