At a glance
- What it is
- A tax election (IRS Form 2553) that lets an LLC or corporation be taxed as an S corporation.
- What it saves
- Self-employment tax (Social Security and Medicare) on the profit you take as distributions instead of salary.
- Best fit
- Often worth a look once profit is consistently $60,000 or more.
- Main catch
- You must pay yourself a reasonable salary through payroll, and file a separate business return.
- Deadline
- Generally March 15 to take effect for the current calendar year.
Key takeaways
- An S corp election lets an LLC split profit into a reasonable salary and distributions, and only the salary carries Social Security and Medicare tax.
- It is often worth a look once business profit is consistently $60,000 or more and the owner actively works in the business.
- In the illustrative example, $150,000 of profit with a $70,000 salary cuts Social Security and Medicare tax by roughly $10,500.
- The catch: you must run payroll at a reasonable salary, file a separate business return, and the election is hard to undo.
Watch the story
A one-minute story about this strategy. Illustrative story; the people are fictional and are not clients. See all story videos.
The numbers
Picture a business owner with $150,000 of net profit. Same business, same customers, same profit. The only thing that changes is how the business is taxed.
For illustration purposes. Tax law may change, which may change these calculations slightly.
| Sole prop / LLC | S corp | |
|---|---|---|
| Net profit | $150,000 | $150,000 |
| Paid as salary through payroll | n/a | $70,000 |
| Profit subject to self-employment or payroll tax | All of it | $70,000 |
| Distributions free of payroll tax | $0 | $80,000 |
The headline figure: $80,000 × 15.3% = $12,240 of payroll tax that no longer applies to the distributions.
A closer look
The $12,240 is the simple version. Self-employment tax is actually calculated on 92.35% of net profit, so here is the side-by-side with that adjustment:
| Sole prop / LLC | S corp | |
|---|---|---|
| Self-employment tax ($150,000 × 92.35% × 15.3%) | $21,194 | n/a |
| Payroll tax on $70,000 salary (employee + employer, 15.3%) | n/a | $10,710 |
| Social Security and Medicare tax | $21,194 | $10,710 |
That is roughly $10,500 less in Social Security and Medicare tax. It is not the whole story, though. Income tax shifts too: the sole proprietor deducts half of self-employment tax, and the Qualified Business Income (Section 199A) deduction is based on profit after the owner’s salary, so a higher salary shrinks it. S corp costs like payroll processing and Oklahoma unemployment tax also come off the top.
This is why we model the election with your real numbers before recommending it. For some owners the net savings are large. For others, especially at lower profit levels, the costs eat most of the benefit.
Could this strategy work for your business?
In a free tax analysis, your tax strategist checks whether it fits and what it could save, using your real numbers.
How it works
- You keep your LLC (or form one). The S corp is a tax status, not a new kind of company. An LLC can elect to be taxed as an S corporation without changing its legal structure.
- You file Form 2553 with the IRS. All owners sign. Once accepted, the business files its own return (Form 1120-S federally, Form 512-S in Oklahoma) and issues each owner a K-1.
- You go on payroll. As an owner who works in the business, you pay yourself a reasonable salary with tax withheld, just like any employee.
- Profit above your salary comes out as distributions. Distributions are still subject to income tax on your personal return, but not to Social Security and Medicare tax.
Who it fits
- Owners with profit that is consistently $60,000 or more and expected to stay there.
- Owners who actively work in the business: contractors, consultants, medical and professional practices, trades, agencies, and similar service businesses.
- Owners willing to run payroll and keep business and personal money separate.
When it is usually not a fit
- Profit is small, brand new, or swings widely from year to year.
- The business mainly holds rental real estate, which usually belongs in its own LLC instead.
- You plan to bring in investors who need different classes of ownership, or owners who are not U.S. citizens or residents.
The rules
- Timing. Form 2553 must generally be filed no more than 2 months and 15 days after the start of the tax year it should apply to (March 15 for a calendar-year business), or anytime in the year before. The IRS grants relief for many late elections, but it is better not to rely on it.
- Eligibility. A domestic business with no more than 100 shareholders, only one class of stock, and only eligible shareholders (generally U.S. citizens and residents, estates, and certain trusts, but not partnerships, corporations, or nonresident aliens).
- Reasonable salary. Your salary must reflect what you would pay someone else to do your job. The IRS looks at your duties, hours, experience, and what similar businesses pay.
- Proportional distributions. Distributions must follow ownership percentages. Paying one owner more than their share can put the election at risk.
- Payroll filings. Quarterly payroll returns, W-2s, federal and Oklahoma withholding, and Oklahoma unemployment tax.
Risks and costs to weigh
- Salary set too low. If the IRS decides your salary is unreasonably low, it can treat distributions as wages and assess the payroll tax, plus penalties and interest.
- Smaller Social Security record. Lower wages mean lower Social Security earnings, which can reduce your future benefits.
- Retirement contributions. Employer contributions to plans like a Solo 401(k) are based on your W-2 salary, not total profit.
- More paperwork. A separate business return, payroll filings, and careful records of your investment in the company.
- Hard to undo. If you revoke the election, you generally cannot re-elect for five years without IRS consent.
How we handle it for clients
With a Cannon & Brown tax plan, we run the numbers before you elect, set a salary we can support, and keep payroll and distributions on track all year. Your business and personal returns are included in your plan. And because Oklahoma S corps can also make the pass-through entity (PTE) election, we look at the two together. Because our technology keeps your numbers current all year, we can test this strategy against your real numbers and adjust it as your business changes.
Illustrative example. The business owner and figures on this page are hypothetical, used to explain how the strategy works. They are not a client and not a promise of results. Figures assume $150,000 of profit and a $70,000 reasonable salary, before payroll costs and income tax effects. This page is educational and is not tax advice for your situation; tax rules and limits change. Talk with a tax professional before making an election.
Brooks leads Cannon & Brown Tax Advisors, a forward-thinking tax firm serving business owners in Oklahoma and beyond. He builds year-round tax strategies that help business owners keep more of what they earn and reach their goals. More about Brooks
Common questions about the S corp election
Can an LLC elect to be taxed as an S corp?
Yes. The S corp is a tax status, not a new kind of company, so an LLC can elect S corp taxation by filing Form 2553 without changing its legal structure.
How much salary should I pay myself as an S corp owner?
Your salary must reflect what you would pay someone else to do your job; the IRS looks at your duties, hours, experience, and what similar businesses pay. Set it too low and the IRS can treat distributions as wages and assess payroll tax, plus penalties and interest.
Is it too late to elect S corp status for this year?
Form 2553 must generally be filed no more than 2 months and 15 days after the start of the tax year it should apply to (March 15 for a calendar-year business), or anytime in the year before. The IRS grants relief for many late elections, but it is better not to rely on it.
Does an S corp lower my income tax too?
Not directly. Distributions are still subject to income tax on your personal return; the main savings are in Social Security and Medicare tax. Income tax shifts in other ways, such as a smaller QBI deduction at a higher salary, so it depends on your numbers, and we check this in your free tax analysis.
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