LLC vs S Corp: When the S Corp Election Saves Tax

An LLC is a legal entity, and an S corporation is a tax election. Most freelancers and consultants who “become an S corp” form an LLC and then file Form 2553 asking the IRS to tax that LLC as an S corporation. The real decision is whether the election pays for itself, and in 2026 that answer depends on three numbers: your profit, the salary you can defend, and what the extra paperwork costs.

• What it saves: self-employment tax on the profit above your salary, and nothing else.
• What it costs: payroll, a corporate tax return, often a state tax, and part of your QBI deduction.

What is the difference between an LLC and an S corp?

A limited liability company is created under state law. It separates your personal assets from the business’s debts, and it costs a filing fee and, in some states, an annual tax. For federal income tax, the IRS ignores a single-member LLC by default: the profit goes on Schedule C of your personal return, exactly as it would for a sole proprietor. An LLC with two or more members is taxed as a partnership.

An S corporation is a tax status under Subchapter S of the tax code. The business still pays no federal income tax itself; profit flows through to the owners’ returns. What changes is how the owner who works in the business gets paid, which is where the savings come from.

The two fit together. Under the Form 2553 instructions, an LLC that elects S status is treated as a corporation from the election’s effective date and does not need to file Form 8832 separately. To qualify, the business can have no more than 100 shareholders, no nonresident alien shareholders, and one class of stock. If you freelance today as a sole proprietor with no entity, you would form an LLC (or a corporation) first, and that entity’s state fees become part of the cost of the election.

How does an S corp election save tax?

As a single-member LLC, you owe self-employment tax on 92.35% of your profit. The rate is 15.3%: 12.4% for Social Security on earnings up to the 2026 wage base of $184,500, and 2.9% for Medicare with no cap. You can deduct half of that tax in figuring your adjusted gross income.

As an S corporation, you become an employee of your own company. The salary carries the same 15.3%, split between the company and you through payroll, and whatever profit remains can be paid to you as a distribution that carries no Social Security or Medicare tax. The saving is that tax on the gap between your profit and your salary.

The gap matters less as income rises, because the Social Security part stops at the wage base. IRS Publication 15 confirms the $184,500 limit for 2026 and the 0.9% Additional Medicare Tax on wages above $200,000. Once your salary reaches the wage base, you are paying the full 12.4% on it either way, and the election only saves Medicare tax on the rest: 2.9%, or 3.8% where the additional tax applies.

How much salary does the IRS require for an S corp owner?

The IRS requires a reasonable salary before any distribution. Its page on S corporation compensation says the company “must pay reasonable compensation to a shareholder-employee in return for services that the employee provides” before non-wage distributions, and that the IRS can reclassify distributions as wages. The factors it lists include your training and experience, your duties, the time you put in, what comparable businesses pay for similar services, and how the business earns its revenue. For a solo consultant, nearly all revenue comes from your own work, which pushes the reasonable salary up.

One of the cases that page lists shows how this plays out. In David E. Watson, P.C. v. United States (8th Cir. 2012), an experienced CPA paid himself a $24,000 salary through his S corporation in 2002 and 2003 while it received roughly $200,000 a year in profit distributions from his firm. The IRS’s expert put the market value of his work at $91,044, the court accepted that figure, and enough of the distributions to reach it were recharacterized as wages subject to employment tax.

A salary picked to make the math work is the one an examiner questions. A defensible number comes from what you would pay someone else to do your job: salary surveys for your role and region, rates you have been paid as an employee, or the share of revenue your own hours produce. Write it down when you set it.

What does the QBI deduction have to do with your salary?

The qualified business income (QBI) deduction under Section 199A lets owners of pass-through businesses deduct up to 20% of their business profit. It was set to expire after 2025; the 2025 reconciliation law removed the expiration date and added a $400 minimum deduction for owners with at least $1,000 of active business income, according to Rev. Proc. 2025-32. The IRS QBI page describes the rules for tax years after 2025.

This is the part quick break-even rules skip. Section 199A(c)(4) excludes reasonable compensation from qualified business income. As an LLC, nearly all of your profit counts toward the deduction. As an S corporation, your salary is wages, not business income, so the deduction applies only to what is left after salary and the company’s share of payroll tax.

At $100,000 of profit, our example LLC owner gets a QBI deduction of $15,367 (limited by taxable income). With a $60,000 salary, the same owner as an S corporation gets $7,074. In the 22% bracket, that difference alone adds roughly $1,800 of income tax, against $4,908 of payroll tax saved.

Above the 2026 threshold of $201,750 of taxable income for single filers ($403,500 joint), the effect can reverse. For a business that is not a specified service business, the deduction phases toward a limit of 50% of W-2 wages paid, and a sole proprietor with no payroll has no wages to count. At $400,000 of profit and a $200,000 salary, a non-service S corporation keeps a QBI deduction of about $37,000, while the same business as an LLC gets none. Consulting, law, accounting, health, financial services and similar fields are specified service businesses, and for them the deduction phases out entirely once taxable income passes $276,750 single, whichever way they are taxed.

When does an S corp save money?

Online rules of thumb often put the break-even around $40,000 of profit. The table below runs the full 2026 federal calculation both ways, income tax included, at four profit levels, and once salary, the QBI deduction and real running costs are counted, the break-even lands higher.

“Payroll tax” counts both the company’s and your share. “Extra income tax” is mostly the smaller QBI deduction. The LLC figure at $250,000 includes $278 of Additional Medicare Tax. The extra costs are deductible, which is why $2,000 costs less than $2,000 after tax.

At $60,000 of profit the election loses money: the payroll tax saved is real, but the smaller QBI deduction and the running costs take all of it. In every row, 30% to 48% of the payroll tax saved comes back as higher income tax, which is the piece most quick estimates leave out.

The salary moves the answer more than anything else. Cut the salary in the $60,000 row to $30,000 and the same calculation saves about $1,500. Whether $30,000 is reasonable pay for a full year of your work is exactly the question the IRS asks, so a break-even that depends on a thin salary is a break-even that depends on never being examined.

A spouse’s income, a state income tax, health insurance and retirement contributions all change the result, so read the table as the shape of the answer and run your own numbers before you file.

What does an S corp cost to run?

The running costs start with payroll. You need to withhold and deposit taxes on your own salary, file quarterly Form 941s and an annual Form 940, issue yourself a W-2, and register for state withholding and unemployment insurance. Most owners pay a payroll service to do this.

The company also files its own return, Form 1120-S, due on the 15th day of the third month after its year ends: March 15, 2027 for a 2026 calendar year, as the Form 1120-S instructions set out. Each owner receives a Schedule K-1 to report on their personal return. Business returns cost more to prepare than a Schedule C; Nino’s guide to what a CPA costs has the survey figures.

Then there is the state. California is the sharpest example. The Franchise Tax Board taxes every S corporation with California income at 1.5% of its net income, with an $800 minimum franchise tax, and an LLC that elects S status files California’s S corporation return, Form 100S. An LLC taxed as a disregarded entity pays an $800 annual tax, plus a fee once its California income reaches $250,000.

Measured against an LLC you already have, the election adds little in California at modest profit: the S corporation’s 1.5% stays under the $800 minimum until its net income after your salary passes about $53,000. In our $250,000 row, that net income is about $129,500, for a tax of $1,943. If you are a sole proprietor with no entity today, though, the whole $800 a year is new cost, and it comes off the savings in the table.

The state side can also pay you back. Many states let a partnership or S corporation elect to pay state income tax at the entity level, which the IRS allows the entity to deduct in Notice 2020-75, outside the $40,400 cap on itemized state and local tax deductions for 2026. In California, that pass-through entity elective tax is open to entities taxed as a partnership or S corporation through 2030. A single-member LLC taxed as a sole proprietorship cannot make it. For a high earner in a high-tax state whose deductions already exceed the cap, this can be worth more than the payroll tax saving. Nino’s guide to 2026 tax changes covers the new cap.

How does an S corp change health insurance and retirement savings?

Health insurance runs through payroll

For an owner of more than 2% of the company, the IRS says the S corporation deducts the premiums and reports them as wages in Box 1 of the owner’s W-2, but not in the Social Security and Medicare boxes. The owner then takes the self-employed health insurance deduction on their personal return. If the company never pays or reimburses the premiums, or leaves them off the W-2, that deduction is at risk. It is also unavailable if you or your spouse was eligible for a subsidized health plan, such as one through your spouse’s employer.

Retirement contributions follow your W-2

In an S corporation, plan contributions are based on your W-2 wages; distributions do not count. A Solo 401(k) allows a $24,500 employee deferral for 2026 plus an employer contribution of 25% of wages, up to a total of $72,000 under the 2026 IRS limits.

The $7,881 gap is room you give up for tax-deferred savings. Reaching the $72,000 cap through an S corporation takes a salary of $190,000 ($47,500 of employer contribution at 25%), which is above the Social Security wage base and leaves little payroll tax to save. Nino’s Solo 401(k) vs SEP IRA comparison walks through both plans, and the SEP IRA guide covers the S corporation version. The SEP IRA calculator runs the numbers.

A lower salary also means lower earnings on your Social Security record, which your future benefit is based on. Over a career of lean salaries, that trade is part of the cost.

When is the S corp election deadline?

Form 2553 is due no more than 2 months and 15 days after the start of the tax year the election should take effect, or at any time during the year before. For a calendar-year LLC that wants S status from January 1, 2027, that means filing by March 15, 2027, and filing any day in the rest of 2026 also works. A new business counts from the earliest of the date it first had owners, first had assets, or began doing business, so a company formed in mid-year has a deadline 2 months and 15 days after that date.

Miss it, and Section 1362(b)(3) treats the election as made for the following year. The Form 2553 instructions describe relief under Rev. Proc. 2013-30 if the business had reasonable cause, acted diligently once it found the mistake, and files within 3 years and 75 days of the intended effective date, with “FILED PURSUANT TO REV. PROC. 2013-30” written at the top of the form. Every shareholder must also have reported their income as if the election had been in effect.

Going back is slow, too. If you revoke the election, Section 1362(g) bars a new one until the fifth tax year after the revocation took effect, unless the IRS consents. That is a good reason to run the numbers before electing rather than trying it for a year.

How Nino helps you decide

The election is a planning decision first and a filing task second: the salary, the projected QBI deduction, the retirement plan and the state cost all need to be set before March 15. Every Nino Advisor plan pairs you with a CPA and Financial Planner who run that comparison with your own numbers and file your personal return, federal and state. If you elect, business bookkeeping and the S corporation’s return are available on Premier, priced by complexity. The consultants and freelancers page covers the rest of what the team handles.

Book a free consultation to see whether the election saves you money in 2027. Every Advisor plan includes a 30-day money-back guarantee; see plans and pricing.