This is one of the most common questions for freelancers, solopreneurs, and small business owners. The answer depends on how much you earn and how you pay yourself.
First: An S Corp Is Not a Business Entity
This trips people up. An LLC is a legal entity you form with your state. An S Corp is a tax election you make with the IRS by filing Form 2553. You can be an LLC that is taxed as an S Corp. They are not mutually exclusive -- in fact, most small businesses that benefit from S Corp taxation start as LLCs and then elect S Corp status.
How an LLC Is Taxed by Default
A single-member LLC is a "disregarded entity" for tax purposes. All income flows through to your personal return on Schedule C. You pay income tax on the full profit, plus self-employment tax (Social Security and Medicare) of 15.3% on the first $168,600 of net earnings (2024 limit) and 2.9% on everything above that.
That self-employment tax adds up fast. On $150,000 of profit, you are paying roughly $22,950 in self-employment tax alone -- on top of your income tax.
How S Corp Taxation Saves Money
When you elect S Corp status, you split your business income into two buckets: a reasonable salary (subject to payroll taxes) and distributions (not subject to self-employment tax). The key word is "reasonable." The IRS requires that you pay yourself a salary that is comparable to what someone in your role and industry would earn.
Using the same $150,000 example: if you pay yourself a $70,000 salary, you pay payroll taxes on that $70,000 (roughly $10,710). The remaining $80,000 comes as a distribution -- no self-employment tax. You just saved over $12,000 in taxes compared to the default LLC treatment.
When the S Corp Election Makes Sense
The S Corp election generally starts making sense when your net business income consistently exceeds $50,000-$60,000 per year. Below that threshold, the additional costs of running payroll, filing a separate S Corp return (Form 1120-S), and potentially higher accounting fees often offset the tax savings.
You also need to be comfortable running formal payroll. As an S Corp, you must pay yourself through payroll with proper withholding, file quarterly payroll tax returns, and issue yourself a W-2 at year end. This adds $500-$2,000+ per year in payroll service costs.
Pass-Through Taxation and the QBI Deduction
Both LLCs and S Corps are pass-through entities, meaning profits flow to your personal tax return. Both can potentially qualify for the Section 199A Qualified Business Income (QBI) deduction, which allows eligible taxpayers to deduct up to 20% of qualified business income. However, the QBI deduction calculation differs slightly for S Corps because wages paid to yourself reduce QBI.
Bottom Line
If your net self-employment income is under $50,000, a standard LLC is usually sufficient. Once you consistently clear $60,000+ in profit, run the numbers on the S Corp election. The self-employment tax savings can be substantial, but only if they outweigh the added administrative costs. Always model it out with real numbers before making the switch.