LLC or S corp: which one actually saves you money
Most people asking this question have already been told the answer is "an S corp saves you self-employment tax". That is true, and it is also the part that gets people into trouble, because an S corp is not a kind of company. It is a tax election that an LLC or a corporation can make. You are not choosing between two entities. You are choosing whether to add an election on top of the entity you already formed.
What the election actually does
As a plain LLC, all of your profit is subject to self-employment tax - 15.3% on the first portion of earnings and 2.9% above it. If you make 90,000 in profit, you pay that on 90,000.
With the S corp election, you split the money in two. You pay yourself a salary, which is subject to payroll tax, and you take the rest as a distribution, which is not. On the same 90,000, a reasonable salary of 55,000 means payroll tax applies to 55,000 and the remaining 35,000 avoids the 15.3%. That is roughly 5,000 saved.
The part that decides it
That saving is not free. An S corp election means running payroll, filing a separate corporate return, and in some states paying an additional franchise or minimum tax. Between payroll software, a bookkeeper and the extra return, plan on 1,200 to 2,500 a year.
So the arithmetic is simple. Below about 45,000 in profit, the election costs more than it saves. Between 45,000 and 80,000 it roughly breaks even and depends on your state. Above about 80,000 in profit it starts to be clearly worth it, and the gap widens the more you make.
Profit means what is left after expenses, not revenue. This is the single most common mistake we see: someone with 200,000 in revenue and 150,000 in costs has 50,000 in profit, and is in the break-even band, not the obvious-yes band.
Reasonable salary is not optional
The rule is that you must pay yourself a reasonable salary for the work you do, before taking distributions. People hear "pay yourself less salary, save more tax" and set a salary of 12,000 on 150,000 of profit. That is the fact pattern the IRS looks for, and when they find it they reclassify the distributions as wages and add penalties.
A defensible salary is what you would have to pay somebody else to do your job. If you are a solo consultant billing 150 an hour, a 20,000 salary is not defensible. If you are running a business that mostly runs itself, a lower salary may well be.
What to do about it
If you have not formed yet, form the LLC. The election can be added later, and it can be added retroactively to the start of the tax year in many cases, so you are not locked out by waiting. Forming as an LLC and electing S corp treatment in year two, when you know what your profit actually looks like, is the normal path and costs you nothing.
If you have already formed and you are above 80,000 in profit, talk to a tax preparer about the election before year end. The deadline for the election to apply to the current tax year is generally two months and fifteen days after the start of it, with relief available for late filings.
- Below 45,000 profit: stay a plain LLC
- 45,000 to 80,000: it depends on your state and your costs
- Above 80,000: worth pricing out properly
- Revenue is not profit, and the difference is the whole calculation