Should Your Business Be an LLC or an S-Corp?

This is one of the most common questions small business owners ask.

And it almost always comes up at the wrong time.

Usually in March, when someone is staring at a tax bill that's bigger than they expected, and a friend mentions that their accountant helped them save thousands by switching to an S corp.

So now you're wondering if you've been leaving money on the table.

Maybe. Maybe not.

Here's what actually matters and how to think through the decision the right way.

First, Let's Clear Up the Confusion

A lot of people think "LLC" and "S-Corp" are two completely different types of businesses.

They're not.

An LLC is a legal structure. It's how your business is set up with the state.

An S-Corp is a tax designation. It's how you tell the IRS to tax your business.

Here's the part that surprises most people: your LLC can be taxed as an S corp.

You don't have to dissolve your LLC and start over. You file IRS Form 2553, and the IRS starts treating your LLC like an S-Corp for tax purposes. The legal structure stays the same. The tax treatment changes.

So when people say "should I be an LLC or an S-Corp," what they're really asking is: should my LLC keep its default tax treatment, or should I elect S-Corp status?

That's the actual question. And the answer depends on your numbers.

How a Default LLC Is Taxed

By default, a single-member LLC is taxed like a sole proprietorship.

All of your business profit flows directly to your personal tax return. You report it on Schedule C. You pay income tax on it at your regular rate.

You also pay self-employment tax on the full amount.

That's 15.3%. It covers Social Security and Medicare, and it applies to every dollar of profit your business earns, whether you transferred that money to yourself or not.

So if your LLC makes $100,000 in profit, you owe self-employment tax on all $100,000. That's roughly $15,300 before income tax even enters the picture.

For a lot of business owners, that number is a shock the first time they see it.

How an S Corp Changes the Math

When your LLC elects S-Corp status, you're required to pay yourself a reasonable salary as a W-2 employee of your own business.

That salary goes through payroll. Taxes are withheld. You get a paycheck.

But here's the difference.

Any profit above your salary can be taken out as a distribution. And distributions are not subject to self-employment tax.

So instead of paying 15.3% on your entire profit, you're only paying payroll taxes on the salary portion.

Here's a simple example.

Say your business nets $120,000.

As a default LLC, you pay self-employment tax on all $120,000.

As an S-Corp, you pay yourself a $70,000 salary. The remaining $50,000 comes out as a distribution. You only pay payroll taxes on the $70,000.

On $50,000 at 15.3%, that's roughly $7,650 in savings.

That's real money. And that's why the S-Corp conversation comes up so often.

The Part People Gloss Over

S-Corp status isn't free.

When you elect S-Corp status, you have to run payroll. That means quarterly payroll filings, W-2s at year end, and a separate business tax return called Form 1120-S.

Most business owners hire a payroll service to handle it. That typically runs $50 to $150 per month.

You also need a bookkeeper or accountant who understands S-Corp compliance, because the filing requirements are more involved than a standard LLC return.

Add it up and the administrative costs of running as an S-Corp can easily be $2,000 to $5,000 per year, depending on who you hire and how complex your books are.

That matters when you're doing the math on whether it's worth it.

So When Does It Actually Make Sense?

The general rule of thumb is that S-Corp status starts to make financial sense when your business is generating $50,000 to $60,000 or more in profit above what you'd pay yourself as a reasonable salary.

Below that threshold, the tax savings often don't outweigh the added cost and complexity.

Above it, the savings start to compound meaningfully year over year.

There's also a timing piece.

To elect S-Corp status for a given tax year, you generally need to file Form 2553 by March 15 of that year. Miss it and you're waiting until the following year. There are late election provisions in some cases, but it's not guaranteed.

The other thing to know: the IRS requires your salary to be reasonable. You can't pay yourself $20,000 and take $100,000 in distributions to dodge payroll taxes. The IRS looks for this specifically. Your salary needs to reflect what someone in your role, with your experience, would earn in the open market.

Which One Is Right for You?

If you're in the early stages of your business and profit is still inconsistent, a default LLC keeps things simple.

Less paperwork. Lower compliance costs. Easier to manage on your own or with minimal help.

If your business is generating consistent profit and you've been paying a large self-employment tax bill every year, it's worth having a real conversation with your bookkeeper or accountant about whether an S corp election makes sense.

Not because it's always the right answer. But because the math is specific to your situation, and the only way to know for sure is to run the numbers.

The Bottom Line

LLC and S-Corp are not an either-or choice.

Most small business owners start as a default LLC and add S-Corp taxation later when the profit level justifies it.

The question is whether your business is at the point where the tax savings outweigh the added complexity.

If you're not sure, that's exactly the kind of thing we look at with clients at Red Leaf Bookkeeping.

Learn more at redleafbookkeeping.com or book a call and we can take a look at your numbers together.