LLC vs. S-corp: when the election actually makes sense

Every founder eventually hears it from someone at a networking event: “You should be an S-corp.” Sometimes that’s great advice. Sometimes it’s an expensive way to feel sophisticated.

First, the thing nobody explains

An S-corp isn’t a different kind of company. It’s a tax election. Your LLC stays an LLC; you just ask the IRS to tax it differently.

As a regular single-member LLC, all of your profit is hit with self-employment tax (about 15.3%, on top of income tax). As an S-corp, you pay yourself a reasonable salary through payroll, and only that salary gets hit with payroll taxes. The rest can come out as distributions, which don’t.

That gap is the savings.

So why not do it on day one?

Because the S-corp comes with overhead:

• You have to run payroll, even if you’re the only employee.
• You file a separate business return (Form 1120-S), which costs money to prepare.
• “Reasonable salary” has to actually be reasonable. Paying yourself $10k while the business makes $200k is how you end up in a conversation with the IRS.

If the business isn’t making much profit yet, those costs can eat the entire savings.

A rough rule of thumb

Once your business is consistently making more profit than a reasonable salary for your role, plus enough extra to cover the added payroll and filing costs, it’s worth running the numbers. For a lot of service businesses, that conversation starts somewhere in the mid five figures of profit.

That’s a starting point, not an answer. Your industry, your state, and what “reasonable” looks like for your role all change the math.

The short version

• Don’t elect just because someone told you to.
• Do elect when the numbers say so.
• Check again every year, because the right answer changes as you grow.

If you’re not sure where you land, drop the question in our Slack channel. This is the kind of thing we like doing math on.