LLC Or S-Corp? Choosing The Right Business Entity For Tax Savings

I see this scenario play out regularly in my practice. Take a typical case: a physical therapist running her own practice as an LLC, earning around $180,000 annually. When tax time arrives, she faces a self-employment tax bill exceeding $25,000 just for Social Security and Medicare taxes. There has to be a better way.

There is. By electing S-Corp taxation, a business owner in this situation could potentially save $12,600 in self-employment taxes annually. That’s over a thousand dollars staying in the business every month instead of going to taxes.

Here’s the thing – most business owners stick with their original entity choice without realizing they’re leaving money on the table. After 26 years helping businesses optimize their tax strategies, I’ve seen this pattern countless times. The LLC vs S-Corp decision isn’t just about legal structure. It’s about keeping more of what you earn.

Let me show you exactly how these structures work and when making the switch can transform your tax situation.

Understanding the Basics: LLC vs S-Corp

The first thing to understand is that we’re not comparing apples to apples here. An LLC is a legal business structure. An S-Corp is a tax election. This distinction matters because it opens up possibilities many business owners never consider.

What is an LLC?

A Limited Liability Company gives you personal asset protection while keeping things simple. By default, the IRS treats single-member LLCs like sole proprietorships and multi-member LLCs like partnerships for tax purposes.

Here’s what that means for your taxes:

• All business profits get reported on your personal tax return
• You pay self-employment tax on 100% of your net earnings
• No separate business tax return (for single-member LLCs)
• Maximum flexibility in profit distribution

What is an S-Corporation?

An S-Corp isn’t a business entity – it’s a tax status you elect with the IRS. When you make this election, you’re telling the IRS, “I want to be taxed differently.” The key advantage? You can split your income between salary and distributions.

S-Corp requirements include:

• Maximum 100 shareholders
• Only U.S. citizens or residents can be owners
• One class of stock only
• No corporate ownership allowed

Entity Classification vs. Tax Election

Here’s where it gets interesting. Your LLC can elect to be taxed as an S-Corp by filing Form 2553. You keep the legal benefits of the LLC while gaining the tax advantages of S-Corp status. It’s the best of both worlds for many business owners.

Tax Advantages of S-Corp vs LLC

The real difference comes down to self-employment taxes. Let me break this down with real numbers.

Self-Employment Tax Savings Explained

For 2025, self-employment tax is 15.3% on income up to $176,100:

• 12.4% for Social Security
• 2.9% for Medicare

LLC taxation: You pay self-employment tax on all business profits.

S-Corp taxation: You only pay employment taxes on your salary, not on distributions.

Let’s say you make $150,000 in business profits:

As an LLC:

• Self-employment tax: $150,000 × 15.3% = $22,950

As an S-Corp (with $80,000 salary, $70,000 distributions):

• Employment tax on salary: $80,000 × 15.3% = $12,240
• Employment tax on distributions: $0
• Total savings: $10,710

Salary vs Distribution Strategy

The S-Corp strategy works because you split your income:

1. Salary: Subject to employment taxes but tax-deductible to the business
2. Distributions: Not subject to employment taxes

The catch? Your salary must be “reasonable” for the work you perform.

IRS Reasonable Compensation Requirement

The IRS requires S-Corp owners who work in the business to pay themselves a reasonable salary. This prevents people from paying themselves $1 and taking everything else as distributions.

Factors the IRS considers:

• Industry salary standards
• Your education and experience
• Hours worked and responsibilities
• Company profitability
• Economic conditions

Reasonable Compensation: Owner Salary Checklist

As an S-Corp owner, your salary must be “reasonable” per IRS guidelines. Here’s a quick checklist to build your rationale:

• Compare to Bureau of Labor Statistics (BLS.gov) data for similar local jobs.
• Review industry norms using job postings, trade groups, or salary surveys.
• Document years of experience, hours worked, and duties performed.
• Get your accountant’s written opinion if unsure.
• Retain written records in case of future audits.

Document your reasoning – if you get audited, you’ll need to justify your salary level. For more, see the IRS page on Reasonable Compensation.

Social Security & Medicare Implications

There’s an important detail about Social Security tax: it only applies to the first $176,100 of income in 2025. Once you hit that threshold, you stop paying the 12.4% Social Security portion.

Medicare tax (2.9%) has no income limit. Plus, high earners pay an additional 0.9% Medicare tax on income over $200,000 (single) or $250,000 (married filing jointly).

Side-by-Side Comparison: LLC vs S-Corp Taxes

The S-Corp requires more paperwork, but the tax savings often justify the extra complexity. When I see clients saving $8,000-$15,000 annually, the additional administrative burden becomes a worthwhile investment.

Hidden Costs and Administrative Requirements

Making the S-Corp election isn’t free. You’ll face additional costs:

Setup costs:

• Form 2553 filing 
• State registration fees (varies by state)
• Legal and accounting setup

Ongoing costs:

• Payroll processing (monthly/quarterly)
• Additional tax return preparation
• Higher accounting fees
• State compliance requirements

I estimate clients spend an additional $3,000-6,000 annually on S-Corp compliance. The tax savings need to exceed these costs to make sense.

When Does it Make Sense to Elect S-Corp Status?

The magic number isn’t set in stone, but I generally see S-Corp elections make sense when net business income exceeds $70,000-$100,000.

Consider S-Corp election when:

• Your net business income is substantial
• You’re comfortable with additional paperwork
• You can justify a reasonable salary
• The tax savings exceed compliance costs

Stick with LLC when:

• Your income is below the break-even threshold
• You have multiple owners with complex profit-sharing
• You want maximum simplicity
• You have foreign investors

Examples: LLC vs S-Corp in Practice

Let me show you how these calculations work in a few different scenarios.

Case Study 1: Marketing Consultant Earning $150K

Consider a marketing consultant operating an LLC that generates $150,000 in net profit annually.

As LLC:

• Self-employment tax: $150,000 × 15.3% = $22,950
• Income tax: varies by bracket

After S-Corp election:

• Reasonable salary: $75,000
• Distributions: $75,000
• Employment tax on salary: $75,000 × 15.3% = $11,475
• Annual savings: $11,475

After accounting for additional compliance costs of approximately $3,000, the net savings would be $8,475 annually.

Case Study 2: Multi-Doctor Dental Practice

Two dentists operating a practice as an LLC with total net income of $400,000 (split 60/40).

As LLC:

• Partner A’s share: $240,000 × 15.3% = $36,720 SE tax
• Partner B’s share: $160,000 × 15.3% = $24,480 SE tax
• Total SE tax: $61,200

After S-Corp election:

• Partner A’s salary: $120,000, distributions: $120,000
• Partner B’s salary: $80,000, distributions: $80,000
• Total employment taxes: ($120,000 + $80,000) × 15.3% = $30,600
• Total savings: $30,600

Even accounting for higher compliance costs, the annual savings would exceed $25,000.

Case Study 3: Tech Startup Seeking Investment

A technology startup currently structured as an LLC and pursuing venture capital funding.

Why an LLC may not be the best fit for raising capital:

• Venture capital firms typically prefer C-Corporations, not LLCs, due to equity structure, preferred stock, and potential Section 1202 Qualified Small Business Stock (QSBS) benefits.
• Complex ownership arrangements are more flexible in a C-Corp format when adding investors or issuing multiple classes of shares.
• S-Corps are limited to 100 shareholders, all of whom must be U.S. citizens or residents, with only one class of stock – restrictions that make them unsuitable for venture-backed companies.

However, for early-stage startups not yet pursuing institutional funding, an LLC can still provide operational flexibility and pass-through taxation in the initial years.

Pro Tip: With the Section 199A deduction now made permanent under the 2025 tax law changes, business owners should revisit entity structure and income planning with their tax advisor to ensure they’re maximizing the full deduction and structuring for long-term efficiency.

Tax Planning for the Future

The tax landscape is always changing. Here’s what affects your LLC vs S-Corp decision:

Section 199A (20% Pass-Through Deduction)

Both LLCs and S-Corps can qualify for the 20% qualified business income (QBI) deduction on pass-through income, subject to income limits and business type restrictions.

Update (July 2025): The Section 199A deduction was made permanent under the One Big Beautiful Bill. While the deduction now has refined phase-in and phase-out rules for high-income taxpayers, its continuation means proactive planning still matters — especially for owners nearing those thresholds. Your tax advisor can help ensure you maximize the deduction within the updated limits.

Strategic Timing of S-Corp Election

The S-Corp election usually takes effect:

• Beginning of the tax year if filed by March 15th
• Beginning of the following year if filed late

You can also make a late election for the prior year under certain circumstances, but it requires specific procedures and IRS approval. For full details, check out the latest IRS guidance and consult a proactive advisor for entity-specific impact.

How to Switch From LLC to S-Corp (or Vice Versa)

Making the switch requires careful planning:

Step 1: File Form 2553 within required timeframes 

Step 2: Set up payroll systems 

Step 3: Determine reasonable salary 

Step 4: Update bookkeeping procedures 

Step 5: Notify state tax authorities

Important: Once you elect S-Corp status, you generally can’t revoke it for five years without IRS consent.

Working With a Tax Advisor to Make The Right Choice

This decision shouldn’t be made in isolation. A qualified tax professional can:

• Calculate your specific tax savings potential
• Help determine reasonable salary levels
• Set up proper payroll and compliance systems
• Provide ongoing tax services to maximize benefits

At Nisanov Tax Group, we specialize in helping business owners optimize their entity structure. Our outsourced CFO services include entity analysis as part of comprehensive tax planning.

Ready to Optimize Your Business Structure?

The LLC vs S-Corp decision can literally save you thousands of dollars annually. But it’s not a one-size-fits-all choice. Your specific situation – income level, business type, growth plans, and personal preferences – all factor into the optimal decision.

Here’s what I recommend: Don’t let another tax year pass without exploring your options. Download our The Tax Savings Blueprint to get a detailed analysis of potential savings for your specific situation.

At Nisanov Tax Group, we’ve helped over a thousand business owners optimize their tax strategies. Our proactive approach means we’re always looking ahead, not just preparing last year’s returns.

Contact us today for a consultation. Let’s analyze your business and show you exactly how much you could save. Because when it comes to taxes, every dollar you keep working for your business instead of the government matters.

After all, the best tax strategy is the one that’s properly implemented and consistently maintained. Let us show you how to build yours.

FAQs