LLC vs. S-Corp: which one actually saves you tax?

The question comes up in almost every first meeting with a business owner: "Should I be an LLC or an S-Corp?" The honest answer starts with clearing up what each one is, because they are not alternatives to each other.

They answer different questions

An LLC is a legal entity registered with your state. It separates your business from you personally, which is mostly about liability protection and clean ownership.

An S-Corp is not a type of entity at all. It is a tax election, made with the IRS on Form 2553, that changes how an existing business is taxed. An LLC can elect S-Corp treatment. So can a corporation. The common path for a small business is: form an LLC first, then decide whether an S-Corp election makes sense.

What a default LLC pays

A single-owner LLC that has not made any election is taxed as a sole proprietorship. All of the profit flows to your personal return, and all of it is subject to self-employment tax, which is roughly 15.3% on net earnings up to the Social Security wage base, plus income tax on top.

That self-employment tax is the number the S-Corp conversation is really about.

What changes with an S-Corp election

With an S-Corp election, you become an employee of your own business. You pay yourself a salary through payroll, and that salary is subject to payroll taxes. Whatever profit is left after your salary is taken as a distribution, and distributions are not subject to self-employment tax.

The saving comes from the gap between total profit and the salary you pay yourself. The larger that gap, the larger the saving.

What it costs

The election is not free, which is why it is not right for everyone:

• Payroll. You must run payroll for yourself, with the filings and deposits that come with it.
• A separate return. The S-Corp files its own return (Form 1120-S) every year, in addition to your personal return.
• A reasonable salary. The IRS expects your salary to be reasonable for the work you do. Paying yourself very little to maximize distributions is the one thing that draws attention.
• State considerations. Some states tax S-Corps differently. Texas has no personal income tax, but franchise tax rules still apply to the entity.

So which one saves more?

For a business with modest profit, the costs of the election can eat the savings. As profit grows, the math tips toward the S-Corp. Where that line falls depends on your profit, what a reasonable salary looks like in your field, and the cost of running payroll.

The right way to decide is to run both scenarios with your real numbers. That is what we do in an S-Corp election review: a break-even analysis first, and the paperwork only if the numbers say yes.