"Should I be an LLC or an S corp?" is one of the most common questions owners ask. The answer starts with a clarification: an LLC is a legal entity formed under state law, while an S corporation is a federal tax classification. An LLC can be taxed as a sole proprietorship, a partnership, a C corporation or an S corporation. The IRS explains the options on its business structures page.

The default: LLC taxed as a sole proprietorship or partnership

By default, a single-member LLC is disregarded and its owner reports profit on Schedule C; a multi-member LLC files a partnership return. In both cases, the owners' share of business profit is generally subject to self-employment tax of 15.3% on net earnings up to the Social Security wage base and 2.9% above it, plus the additional Medicare tax where it applies.

What changes with an S election

When the LLC files Form 2553:

  • The owner who works in the business becomes an employee and must receive reasonable compensation through payroll
  • Social Security and Medicare taxes apply to that salary, split between employer and employee shares
  • Remaining profit can be distributed without Social Security and Medicare taxes
  • The business files Form 1120-S and issues a K-1
  • Payroll filings, state unemployment accounts and often additional state returns are required

A simplified illustration

Consider an owner whose business earns a steady profit and who could reasonably be paid a salary well below that profit. As a default LLC, the full profit is subject to self-employment tax. As an S corporation, only the salary is subject to payroll taxes. The difference can be meaningful, but it is reduced by payroll costs, extra return preparation, state taxes in some states and the effect on retirement contributions and the QBI deduction.

When an election tends to make sense

  • Profit is consistently well above a reasonable salary for the owner's role
  • The owner is ready to run regular payroll and keep corporate formalities
  • The state does not impose costs that cancel the benefit

When it usually does not

  • Profits are low or volatile
  • The owner needs to take all profit to live on, so salary would approach profit anyway
  • The business is likely to have losses the owner wants to use

Liability protection comes from the LLC or corporation under state law, not from the tax election. Electing S status does not change it.

Our tax services team runs the numbers with your actual profit before you decide.

Practical differences in day-to-day bookkeeping

An LLC taxed as a sole proprietorship or partnership generally pays owners through draws or guaranteed payments, and income flows to owners regardless of how much they take out. Once an S corporation election is in effect, owners who work in the business are generally paid wages through payroll, with payroll tax deposits, quarterly payroll returns and W-2s. Distributions are recorded separately from wages, and shareholder basis tracking becomes important.

That added administration has a cost: payroll software or service fees, extra tax return preparation and more year-end work. Comparing projected savings with these costs is a key part of the decision.

Key terms

Definitions for terms used in this guide, from our small business glossary:

  • Guaranteed Payments: Guaranteed payments are payments a partnership makes to a partner for services or use of capital, regardless of profit.
  • Self-Employment Tax: Self-employment tax is the Social Security and Medicare tax paid by people who work for themselves, calculated on net earnings from self-employment.