A question we hear often at Klein Mirsky: "Should I be an LLC or an S corp?" The honest answer starts with a clarification, because the two are not the same kind of thing.
An LLC is a legal entity. An S corp is a tax election
An LLC (limited liability company) is a business structure formed at the state level. By default, a single-member LLC is taxed as a sole proprietorship and a multi-member LLC as a partnership. An S corporation is not an entity you form. It is an election you make with the IRS about how an entity is taxed. An LLC can elect to be taxed as an S corp and keep all of its legal LLC protections.
So the real question usually is not "LLC or S corp?" It is: "Should my LLC elect S corp tax treatment?"
Where the tax difference shows up: self-employment tax
As a default LLC, all of your net business profit is generally subject to self-employment tax (Social Security and Medicare) on top of income tax. With an S corp election, you pay yourself a reasonable salary (subject to payroll taxes), and the remaining profit can be taken as distributions that are generally not subject to self-employment tax. For a profitable business, that split can produce real savings.
The trade-offs S corp status brings
The election is not free of friction. It comes with:
- A "reasonable compensation" requirement. The IRS expects your salary to reflect the work you do; setting it artificially low to dodge payroll tax is a known audit flag.
- Payroll and added filings. Running payroll, plus a separate business return (Form 1120-S) and K-1s.
- Administrative cost. Payroll service, bookkeeping, and preparation fees that eat into the savings at lower profit levels.
So when does it make sense?
As a rule of thumb, the S corp election starts to pay off once a business is consistently profitable enough that the self-employment tax saved on distributions clearly exceeds the added payroll and compliance costs. Below that point, the simpler default treatment is often the better deal. The threshold depends on your profit, your reasonable salary, your state, and your goals, which is exactly why it is worth running the numbers rather than following a rule of thumb.