LLC vs S-Corp: The Real Break-Even Math

The Advice You Have Probably Heard

Somewhere in your first year of running an LLC, you heard it. From a friend, a CPA, a YouTube video, a forum post at 2am. "You should elect S-Corp status. You will save thousands on self-employment tax." The advice is not wrong. It is just incomplete. The savings only kick in above a certain income threshold, and the ongoing overhead of actually running an S-Corp eats through whatever you save until your income crosses that line.

The right question is not "will an S-Corp save me money." The right question is "at what income does the S-Corp election finally beat the LLC default." Let's actually run the numbers.

How the Self-Employment Tax Actually Works

As a single-member LLC, the IRS treats you as a sole proprietor. Your business profit flows to your personal Schedule C. On that profit, you owe two things: ordinary income tax at your marginal rate, and self-employment tax at 15.3 percent on roughly the first $168,000 of net earnings.

That 15.3 percent is 12.4 percent Social Security plus 2.9 percent Medicare. It is basically both sides of FICA, employer and employee, and you pay both because you are both. On a W-2 job, your employer covers half. As a sole proprietor, the whole 15.3 percent is yours.

On $100,000 of net profit, that is roughly $15,300 in self-employment tax alone, before you touch income tax. That is the number the S-Corp election is designed to shrink.

How the S-Corp Election Changes the Math

When your LLC elects S-Corp taxation (by filing Form 2553), your income splits into two buckets: a reasonable salary and a distribution. The salary runs through payroll and gets hit with the same 15.3 percent FICA as any W-2 job. The distribution is not subject to self-employment tax at all.

Run the stylized example. Business profit of $100,000. You pay yourself a $60,000 salary and take the remaining $40,000 as distribution. You owe 15.3 percent FICA on the $60,000 salary, which is roughly $9,180. You owe nothing in self-employment tax on the $40,000 distribution. Under the LLC default, you would have paid $15,300 on the full $100,000. On paper, you just saved about $6,000. Congratulations. Do not spend it yet.

The Costs the Advice Usually Skips

Here is what the pitch leaves out. That $6,000 in tax savings does not land in your bank account. Running an S-Corp legitimately means running new overhead:

• Payroll processing. $500 to $1,500 a year for Gusto, OnPay, or similar to run payroll and file quarterly returns for you.
• Bookkeeping and accounting. $1,200 to $3,000 a year, because an S-Corp requires cleaner books than a Schedule C, and your CPA will charge more for the return.
• State filing fees and franchise taxes. $100 to $800 a year depending on your state. California, for the record, hits every S-Corp with an $800 minimum franchise tax.
• State corporate income taxes. A handful of states impose additional taxes on S-Corps that a pass-through LLC would never owe.

Realistic annual overhead for a small S-Corp lands in the $2,000 to $4,000 range. That is the number your tax savings have to beat before the election puts money in your pocket.

The State-by-State Spread Is Wider Than You Think

Your state changes the math more than most CPAs bother to explain. California hits every S-Corp with an $800 minimum franchise tax plus a 1.5 percent tax on net income. New York charges a fixed-dollar franchise tax that scales with receipts. Texas imposes a margin tax on S-Corps that pass-through LLCs avoid entirely. Meanwhile, Wyoming, South Dakota, and Nevada charge nothing beyond a basic filing fee.

The ten states where S-Corp elections are most common, ranked by what the state alone adds to your annual overhead: California ($800+ franchise tax, 1.5% income tax), New York ($25 to $4,500 franchise tax by receipts), Illinois ($75 franchise tax plus 1.5% replacement tax), New Jersey ($500 minimum tax), Texas (0.375% to 0.75% margin tax), Massachusetts ($456 minimum excise), Pennsylvania ($0 corporate tax on S-Corps but capital stock tax until recently phased out), Florida ($0 state income tax on S-Corps), Washington ($0 corporate income tax, but B&O tax still applies), and Wyoming ($60 filing fee, nothing else). The spread between California and Wyoming is over $2,000 a year before you've done a single thing. That $2,000 comes straight out of your S-Corp tax savings.

What the Math Looks Like When You Switch Too Early

Here's the reverse calculation nobody shows you. Take $50,000 in net profit. Under the default LLC, you pay roughly $7,650 in self-employment tax (15.3 percent on the full amount). Painful. Now elect S-Corp and pay yourself a $35,000 salary. Your FICA on that salary is about $5,355. Self-employment tax on the remaining $15,000 distribution: zero. Gross savings: $2,295.

Now subtract the overhead. Payroll processing: $900 a year. Your CPA charges an extra $600 for the S-Corp return. California's franchise tax: $800. You just spent $2,300 to save $2,295. Congratulations, you broke exactly even and added a stack of quarterly filings to your life. In most states the math is a little kinder, but at $50,000 the savings are thin enough that one unexpected accounting bill wipes them out.

The Actual Break-Even Point

Work backward from the overhead. If the ongoing cost of running an S-Corp is roughly $3,000 a year, your self-employment tax savings need to clear at least that. Because self-employment tax runs about 15 percent on income above your reasonable salary, you generally need distributions of at least $20,000 a year to make the math work.

In practice, that means the S-Corp election starts saving you money around $60,000 to $80,000 of net profit. It starts saving meaningful money at $100,000 and up. Below $60,000 in net profit, the overhead usually swallows the tax savings whole, and you are better off staying an LLC taxed as a sole proprietor. This is the part the "you have to switch to an S-Corp" advice always leaves out.

The "Reasonable Salary" Catch That Trips Founders Up

The IRS requires the salary portion of your S-Corp income to be "reasonable" for the work you actually perform. You cannot pay yourself $10,000 and take the other $90,000 as a distribution. If the IRS audits you and decides your salary was artificially low, they reclassify the distributions as wages and hit you with back FICA taxes plus penalties. You do not want that phone call.

What counts as reasonable is not one clean number. It depends on your industry, geography, experience, and the specific work you do. The CPA rule of thumb is the 60/40 split. Sixty percent salary, forty percent distribution. It generally holds up under audit. It is not a legal safe harbor, and anyone selling it to you as one is overstating the case.

How real is the audit risk? The IRS audited roughly 0.3 percent of S-Corp returns overall in recent years. At income above $200,000, the rate climbs to about 1.1 percent. The "reasonable salary" question is the single most common adjustment when they do look. That's not a reason to panic. It's a reason to pick a defensible salary and keep the documentation that supports it, because the IRS doesn't need to audit you to flag the return. Automated screening catches the obvious outliers first.

When the S-Corp Election Does Not Make Sense

Even above the break-even income, the election is not automatically the right move. Skip it if:

• You reinvest most of your profit into the business instead of paying yourself distributions.
• You are planning to raise institutional capital. VCs do not invest in S-Corps.
• Your income is variable and you cannot commit to running consistent payroll.
• You are new enough to running a business that you do not yet have the operational discipline to keep books clean and payroll on schedule.

The election is a commitment. Reversing it and going back to LLC pass-through taxation is possible but painful, and the IRS may block re-election for several years after.

The Practical Takeaway

If your business consistently clears $80,000 in net profit and you pay yourself the majority of it as personal income, the S-Corp election is probably worth running. Below that threshold, keep your LLC on default pass-through taxation and revisit at year-end.

Above the threshold, run the numbers with a CPA before you file Form 2553. The math is not hard. The operational commitment is real. And an election filed for the wrong reason at the wrong income costs you more than it saves.