LLC vs S-Corp: Which Business Structure Saves You More?

How LLCs Are Taxed

By default, the IRS does not recognize an LLC as a separate tax entity. Instead, it is taxed based on how many members (owners) it has:

• Single-member LLC: Treated as a "disregarded entity." All profit and loss is reported on Schedule C of your personal Form 1040. The entire net profit is subject to both income tax and 15.3% self-employment tax (12.4% for Social Security on the first $168,600 of earnings for 2025, plus 2.9% for Medicare on all earnings, plus an additional 0.9% Medicare surtax on earnings above $200,000).
• Multi-member LLC: Taxed as a partnership by default. The LLC files Form 1065 and issues a Schedule K-1 to each member. Each member's share of profit is subject to self-employment tax.

The critical point: with a standard LLC, every dollar of net profit goes through self-employment tax. There is no way to split income between salary and distributions. This is where the S-Corp election becomes valuable for profitable businesses.

An LLC can also elect to be taxed as an S-Corp by filing Form 2553 with the IRS. You remain an LLC for legal purposes but gain the tax treatment of an S-Corp. This is the most common path - you do not need to form a separate corporation.

How S-Corps Are Taxed

An S-Corp is a tax election, not a separate entity type. When your LLC elects S-Corp status, the tax treatment changes significantly:

• You must pay yourself a reasonable salary through actual payroll. This salary is subject to payroll taxes (the equivalent of self-employment tax) - the employer pays 7.65% and the employee pays 7.65%, totaling 15.3%.
• Remaining profit is distributed as dividends (technically "distributions") that are subject to income tax but NOT self-employment / payroll tax.

The savings come from that second point. By splitting your business income between a reasonable salary and distributions, you avoid paying the 15.3% payroll tax on the distribution portion. The salary must be "reasonable" for your role, industry, and location - the IRS will challenge salaries that are artificially low.

S-Corps are pass-through entities just like LLCs. The business itself does not pay federal income tax. Instead, profits flow through to your personal return via Schedule K-1, where they are taxed at your individual rate.

When Should You Make the S-Corp Election?

The general rule of thumb: when your net business profit consistently exceeds $40,000 to $50,000 per year, the S-Corp election typically starts saving you money after accounting for the additional costs.

Here is the math behind that threshold. The S-Corp election brings added costs:

• Payroll processing: $500 - $1,500 per year for a payroll service
• Additional CPA fees: $1,000 - $2,000+ per year for the 1120S tax return and related filings
• Bookkeeping complexity: More detailed record-keeping requirements

At $40,000 net profit with a $25,000 salary, the SE tax savings would be roughly $2,295. After subtracting $1,500 - $2,500 in extra costs, your net benefit is small or possibly negative. At $80,000+ net profit, the savings grow substantially and easily justify the added expense.

If your income fluctuates significantly year to year, or if you are in the early stages of building your business, staying as a standard LLC keeps things simple and avoids the payroll and filing overhead. You can always elect S-Corp status later when it makes financial sense.

S-Corp Requirements and Deadlines

If you decide to move forward with the S-Corp election, here is what is required:

• File Form 2553 with the IRS. To take effect for the current tax year, this form must be filed by March 15 of that year (or within 75 days of forming your LLC). Late elections may still be accepted with reasonable cause.
• Pay yourself a reasonable salary. This must be done through actual payroll - not just writing yourself a check. The salary must be comparable to what someone in your role and industry would earn.
• Run payroll consistently. You must withhold income tax, Social Security, and Medicare from your paycheck and remit payroll taxes to the IRS (typically quarterly). Most business owners use a payroll service to handle this.
• Maintain separate bookkeeping. Keep business and personal finances clearly separated. Track all income, expenses, salary payments, and distributions.
• File Form 1120S annually. This S-Corp tax return is due March 15 (or September 15 with an extension). Each shareholder receives a Schedule K-1 showing their share of income, deductions, and credits.
• Issue W-2s by January 31 for all officer salaries paid during the prior year.
• File quarterly payroll returns: Form 941 (federal), plus state-specific forms (Illinois uses Form IL-941).

Common Mistakes to Avoid

• Setting your salary too low. This is the number one red flag for the IRS. If your business earns $200,000 and you pay yourself $30,000, the IRS will reclassify distributions as wages and assess back payroll taxes, penalties, and interest. Research comparable salaries for your role using the Bureau of Labor Statistics or salary databases.
• Not running actual payroll. Some business owners try to just write themselves a check and call it a salary. The IRS requires real payroll processing with proper withholding, W-2 issuance, and quarterly filings. Skipping this exposes you to penalties.
• Missing the election deadline. Form 2553 must be filed by March 15 of the year you want the election to take effect. Missing this means waiting until the next tax year (unless you qualify for late election relief).
• Not maintaining corporate formalities. Even though an S-Corp taxed LLC is simpler than a C-Corp, you should keep business finances separate, maintain reasonable records, and not treat the business bank account as a personal piggy bank. Mixing funds can jeopardize your liability protection.
• Electing S-Corp status too early. If your business is new, unprofitable, or inconsistent in revenue, the added costs of payroll and tax preparation can outweigh the SE tax savings. Wait until you have consistent profitability above the threshold.
• Forgetting state-level requirements. Some states (including Illinois) require a separate S-Corp election at the state level or have additional fees. Illinois imposes a 1.5% replacement tax on S-Corp income. Make sure your CPA accounts for state-specific rules.