Should Your Business Be an LLC or S-Corp? A Plain English Guide

One of the most common questions small business owners ask is whether they should operate as an LLC or elect S-Corp tax status. The answer isn't one-size-fits-all — but understanding the difference can potentially save you thousands of dollars in taxes every year. Here's a plain English explanation of both.

First — LLC Is a Legal Structure, S-Corp Is a Tax Election

This is the most important thing to understand. An LLC (Limited Liability Company) is a legal entity that protects your personal assets from business liabilities. An S-Corporation is a tax classification you elect with the IRS — it tells the IRS how you want your business income to be taxed.

You can actually be an LLC and elect to be taxed as an S-Corp. Many small business owners do exactly this.

How Self-Employment Tax Works for a Single-Member LLC

If you're a sole proprietor or single-member LLC taxed as a disregarded entity, all of your net business profit is subject to self-employment tax — 15.3% on the first $160,000 or so. That's Social Security and Medicare taxes that employees and employers split, but as a self-employed person you pay both sides.

On $100,000 of profit that's $14,130 in self-employment tax alone — before income tax.

How S-Corp Status Reduces That Tax

When you elect S-Corp status, you split your business income into two parts: a reasonable salary (subject to payroll taxes) and a distribution (not subject to self-employment tax).

Example: $150,000 in business profit. You pay yourself a reasonable salary of $80,000. The remaining $70,000 comes out as a distribution — saving you roughly $10,710 in self-employment taxes (15.3% × $70,000).

The Reasonable Salary Requirement

The IRS requires that S-Corp owner-employees pay themselves a reasonable salary for the work they perform. You can't pay yourself $1 in salary and take $149,999 in distributions to avoid all payroll taxes. The IRS watches for this and will reclassify distributions as wages if your salary isn't reasonable for your role and industry.

At What Income Level Does S-Corp Make Sense?

Generally speaking the S-Corp election starts to make financial sense when your net business profit is consistently above $40,000-50,000 per year. Below that the administrative costs of running payroll and filing an additional tax return may offset the tax savings.

Above $80,000-100,000 in net profit the savings become significant and the S-Corp election is almost always worth it.

The Additional Administrative Requirements

S-Corps require you to run payroll (at minimum quarterly), file a separate business tax return (Form 1120-S), and maintain more formal corporate records. These add cost and complexity — typically $500-2,000/year in additional accounting fees depending on your situation.

Important note: This article is general education and not tax advice for your specific situation. Tax law is complex and the right structure for your business depends on many factors. Always consult with a qualified tax professional before making entity structure decisions.

Have questions about your business structure or want to understand your tax situation better? Schedule a free consultation with Hilkey Financial Group at HilkeyFinancial.com.