Profits are growing, but so are the self-employment taxes eating into them. That’s why so many sole proprietors and single-member LLC (SMLLC) owners wonder if electing S Corp status could help keep more money in their pocket.

The advice can feel all over the place. Some CPAs pitch the S Corp election like it’s a magic bullet for cutting taxes. Others argue it’s not worth the hassle and that sticking with the default SMLLC setup is simpler.

Here’s the truth: there’s no one-size-fits-all answer. The right choice depends on your profit level, how comfortable you are with administrative complexity, and the state rules where you operate. And while multi-member LLCs are taxed differently (as partnerships, with their own set of planning strategies), this breakdown focuses on sole proprietors and SMLLCs deciding whether an S Corp election makes sense.

Let’s break down exactly when each structure makes sense—and when it doesn’t.

Quick Note: LLC vs. SMLLC

You’ll see the terms LLC and SMLLC used a lot, sometimes interchangeably. Here’s the distinction:

• LLC (Limited Liability Company): A legal business structure available in every state. An LLC can have one owner or multiple owners.

• SMLLC (Single-Member LLC): An LLC with just one owner. By default, the IRS treats an SMLLC as a disregarded entity, meaning it’s taxed the same as a sole proprietorship. All income and expenses flow directly onto Schedule C of your personal return.

If an LLC has more than one member, it defaults to partnership taxation (Form 1065) unless it makes an election to be treated as an S Corp or C Corp.

This article focuses on sole proprietors and SMLLC owners deciding whether an S Corp election makes sense.

The Self-Employment Tax Problem

Before deciding on a structure, it’s worth understanding the tax that drives this whole debate: the self-employment tax.

If you operate as a sole proprietor or a single-member LLC (SMLLC, treated as a disregarded entity) without any special election, all of your net profit is subject to self-employment tax.

For 2025, the self-employment tax rate is 15.3% on net earnings up to $176,100. That breaks down to:

• 12.4% for Social Security

• 2.9% for Medicare

Think of it this way: when you worked as an employee, your employer paid half of these payroll taxes. As a sole proprietor, you’re both employer and employee—so you cover the full amount.

High-income note: Once your earnings pass the Social Security wage base ($176,100 in 2025), the 12.4% Social Security portion stops. Only the 2.9% Medicare tax continues, plus a potential 0.9% Additional Medicare Tax if your income is over $200,000 (single) or $250,000 (married filing jointly).

Example – Consultant with $80,000 profit

• Net profit: $80,000

• Self-employment tax: $12,240

• That’s before federal and state income taxes even come into play.

For many sole proprietors, once profits hit the $60,000–$100,000 range, the self-employment tax bite is what makes them start asking whether an S Corp election could change the math.

The SMLLC Advantage: Flexibility Without Complexity

A single-member LLC (SMLLC) offers its own benefits: flexibility without added complexity.

By default, an SMLLC is treated as a disregarded entity, meaning it’s taxed just like a sole proprietorship. You report business income and expenses directly on your personal return (Schedule C), with no separate federal business tax return required.

But SMLLCs are more than a one-track option. You can choose how they’re taxed:

• Default (disregarded entity): Simple filing, but all profits are subject to self-employment tax.

• S Corp election: File Form 2553 to have your LLC taxed as an S Corp, allowing the same self-employment tax savings described earlier.

This flexibility is why many sole proprietors start with an SMLLC. You get liability protection, a simple default tax setup, and the ability to “level up” later by making an S Corp election once profits grow enough to justify the added complexity.

Just remember: states often have their own annual fees or filing requirements for LLCs. For example, California’s $800 minimum applies even if you stick with the default SMLLC.

How S Corp Election Can Cut Your Tax Bill

Here’s how the S Corp election saves tax. When you elect to have your LLC or corporation taxed as an S Corp, you can split your income into two buckets:

1. Salary — subject to payroll taxes

2. Distributions — not subject to self-employment tax

That split is the core of the savings. But the IRS requires owners who actively work in their business to pay themselves a reasonable salary before taking distributions.

What Counts as “Reasonable”?

For sole proprietors and SMLLCs, reasonable compensation is generally what you’d pay someone else to do the same job. You can support this with:

• Salary.com or Glassdoor data for your role

• Bureau of Labor Statistics (BLS) wage data

• Job postings for comparable positions

As Ludmila Hermanovich, Sr. Tax Manager at Town, explains: “The safest approach is to tie your salary to real data. If the IRS asks, you want to show that your number wasn’t pulled out of thin air.”

Real-World Examples

Example 1 – Where savings are strong

• Mara, a solo IT consultant, nets $120,000 in profit.

• Market data (BLS) shows $80,000 is a fair salary for a senior IT professional.

• She pays herself $80,000 in salary and takes $40,000 as distributions.

• Payroll taxes on salary: $12,240

• Payroll taxes avoided on distributions: $6,120

• Extra costs: ~$1,500 payroll service + ~$2,500 tax prep = $4,000

• Net savings = ~$2,100

Example 2 – Where savings are limited

• Owen, a freelance copywriter, nets $65,000 in profit.

• Market data shows that a fair salary for a senior copywriter is $60,000–$65,000.

• He pays himself $62,000 in salary and only has $3,000 left as distributions.

• Payroll taxes avoided: $459

• Extra costs: ~$1,500 payroll service + ~$2,500 tax prep = $4,000

• Net result: the S Corp election actually costs more than it saves.

A Critical Caution

If your reasonable salary exceeds profit, there’s nothing left to treat as distributions—so the election can increase your total costs once payroll and tax prep are included.

As Ludmila Hermanovich explains: “When profit is still modest, it often makes more sense to wait. Once there’s room for both a market-rate salary and distributions, that’s when an S corp pays off.”

A Word on Audit Risk

The IRS has flagged underpaid salaries in S Corps as an enforcement priority. Owners who try to pay themselves $20,000 and take $100,000 in distributions in an industry where peers earn $80,000 risk reclassification. If audited, the IRS can recharacterize distributions as wages, assess back payroll taxes, penalties, and interest.

Running the Numbers: When S Corp Election Makes Sense

The S Corp election usually becomes worthwhile once profits consistently exceed $70,000–$80,000. Below that, the compliance costs often eat up the tax savings.

Example – Business nets $75,000

At $75,000 profit, the S Corp doesn’t make sense. The compliance costs outweigh the tax savings. 

Ludmila Hermanovich advises: “At this stage, it’s usually smarter to wait and focus on growing profit. Once you’re above the break-even point, the S Corp election becomes a real advantage.”

Example – Business nets $120,000

At $120,000 profit, the S Corp election pays off. Even after paying for payroll and CPA-prepared Form 1120S, the owner keeps about $2,100 more. As profits rise further, the annual savings compound.

Don’t Forget the QBI Deduction

Both SMLLCs and S Corps can qualify for the Qualified Business Income (QBI) deduction, which allows eligible owners of pass-through businesses to deduct up to 20% of qualified business income on their personal return.

Under the 2025 One Big Beautiful Bill Act, the QBI deduction was made permanent. That means pass-through owners like sole proprietors and S Corp shareholders can continue claiming it beyond 2025.

However, note that wages paid to an S Corp owner as “reasonable compensation” are not considered qualified business income and therefore do not qualify for the QBI deduction. Only the remaining profits (the distributions) are eligible.

A few key points:

• The deduction applies whether you stick with the default SMLLC setup or elect S Corp status.

• The 20% deduction is subject to income thresholds and phase-outs (especially for service businesses such as consultants, accountants, and attorneys).

• The S Corp election doesn’t create or eliminate QBI eligibility—it simply changes how much of your income is treated as salary versus pass-through business profit.

As Ludmila Hermanovich notes: “QBI is a nice bonus for many small business owners, but it doesn’t replace the salary-versus-distribution analysis. We always model both together.”

Admin Reality Check for S Corporations

An S corp election isn’t just a checkbox—it adds ongoing payroll, filings, and documentation:

• Payroll management: You must run actual payroll for your salary, including quarterly payroll tax deposits and annual W-2s. Most owners either subscribe to payroll software or hire a provider to avoid very costly mistakes.

• Separate business tax return: An S Corp files Form 1120S each year, in addition to your personal return. While the income still passes through to you on a Schedule K-1, the corporate-level return adds complexity.

• Reasonable salary documentation: You need to back up how you set your reasonable compensation. Industry salary surveys, Bureau of Labor Statistics data, and job postings are common ways to support your number if the IRS asks.

By contrast, a default SMLLC avoids these extra steps. Business income flows directly onto Schedule C of your personal return, with no payroll or separate corporate return required.

What If You Forgot to Pay Yourself Through Payroll?

One of the biggest compliance pitfalls for new S Corp owners is forgetting to run payroll for themselves. Distributions alone don’t satisfy the IRS’s requirement that you take a reasonable salary.

Can You Just Issue Yourself a 1099 Instead?

No. As an S Corp owner-employee, you’re considered an employee of your own corporation—not an independent contractor. Issuing yourself a Form 1099-NEC is not allowed and will raise red flags if the IRS audits your return.

If You Catch It Before Year-End

• Run catch-up payroll: Process payroll for yourself before December 31 so that your W-2 reflects the full year’s salary.

• Reclassify distributions: If you’ve already taken draws, part of those can be reclassified as wages when running catch-up payroll.

• Document the adjustment: Keep records showing how you calculated reasonable compensation and how you corrected the oversight.

If It’s Already After Year-End

• Late payroll filings: You may be able to file late Forms 941 and W-2 and pay back taxes, penalties, and interest; discuss reasonable cause relief with a CPA.

• Request penalty relief: If there’s a legitimate reason (illness, CPA transition, software issues), you can sometimes request abatement of penalties.

• Move forward cleanly: Often, the best step is to accept that you won’t get the intended savings for last year and make sure payroll is in place for the new year.

As Ludmila Hermanovich puts it: “The IRS is far more lenient when owners make good-faith corrections quickly. Ignoring payroll altogether is what creates lasting problems.”

State Tax Considerations

Federal tax savings are only part of the picture. States have their own rules for LLCs and S Corps, and those rules can tilt the math one way or the other. 

• California – Both SMLLCs and S Corps pay an $800 annual franchise tax. In addition, SMLLCs pay a gross-receipts-based fee if revenue exceeds $250,000, while S Corps pay a 1.5% income-based tax. Depending on your profit level, one can be cheaper than the other.

• New York – New York recognizes S Corps, but requires them to pay an annual franchise tax based on gross receipts. LLCs pay a fixed annual filing fee that scales with income, which can be simpler for lower-profit businesses.

• Texas – No state income tax, which means the federal comparison (SMLLC vs. S Corp) is the main driver. However, both LLCs and S Corps may be subject to the Texas Franchise Tax once revenues exceed $2.47 million (2025 threshold).

• Other states – Some states don’t recognize S Corps at all, taxing them as regular corporations. Others impose special filing fees for LLCs. Always check local rules before making the election.

As Ludmila Hermanovich notes: “State fees are the hidden part of the calculation. We always run a side-by-side at the state level—sometimes the federal savings are wiped out by state costs.”

S Corp Election Timeline

If you decide the S Corp election makes sense, timing is critical. To have it apply for the current tax year, you generally must file Form 2553 with the IRS by March 15 (for calendar-year businesses). 

Note that electing S Corp status changes only tax treatment—not your entity’s legal form with the Secretary of State or liability protection.

Newly formed businesses generally have 75 days from formation/start of activity to elect S corporation status.

• Missed the deadline? The IRS does allow late elections if you can show reasonable cause, but it’s cleaner to plan ahead.

• Mid-year elections aren’t retroactive. If you wait until June, the election usually only applies from that point forward—not for the full year.

• Best practice: Decide early in the year whether the S Corp election makes sense. That gives you time to set up payroll and avoid messy catch-up filings.

As Ludmila Hermanovich advises: “Think of March 15 as the real deadline to get your house in order. If you’re on the fence, run the numbers in February so you’re not rushing into a decision.”

Special Case: Foreign-Owned Disregarded Entities

If you are a foreign individual or company and own a single-member LLC (SMLLC), the rules are quite different. Foreign-owned SMLLCs must file Form 5472 each year to report transactions with their foreign related parties, along with a pro forma corporate return to report certain transactions with the foreign owner. The penalty for failing to file is steep—$25,000 per year.

We’ll cover the details in a separate article, so stay tuned if this situation applies to you.

Making the Right Choice for Your Business

At the end of the day, choosing between an SMLLC and an S Corp election comes down to three factors:

1. Profit level – Below $70,000, the savings rarely outweigh the costs. Once profits are consistently higher, the S Corp starts to make sense.

2. Administrative comfort – An S Corp requires payroll, a separate tax return, and salary documentation. If you’re not ready for that level of compliance, sticking with the SMLLC is safer.

3. State rules – Franchise taxes and filing fees can tilt the math in either direction, so don’t overlook them.

For many sole proprietors, the best path is to start as an SMLLC and only elect S Corp once profits are high enough to justify the overhead. That’s why timing matters as much as structure.

Bottom line: There’s no universal answer. Run the numbers, check your state’s fees, and be honest about how much compliance you’re willing to take on. The right choice is the one that matches both your profit level and your capacity to manage the extra requirements.

As Ludmila Hermanovich puts it, “The S Corp is a fantastic tool once the numbers line up. But until then, keeping things simple with an SMLLC lets you focus on growing your business. Don’t let the tax tail wag the dog.”

Quick FAQs

Can I switch back from an S Corp to an SMLLC? Yes, but you’ll need to file paperwork with the IRS to revoke the election. Once revoked, you generally must wait five years before re-electing S Corp status unless the IRS grants permission.

What if my income is irregular from year to year? If profits fluctuate below and above $70,000, it may be better to wait until income stabilizes before making the S Corp election. Consistency makes the compliance costs worthwhile.

Can I make the S Corp election mid-year? Usually no. Elections apply to the full tax year if filed by March 15 (for calendar-year taxpayers). Late elections can sometimes be accepted with reasonable cause, but it’s better to plan ahead.

Take Action: Your Next Steps

Still under $70k? Don’t stress—keep it simple with an SMLLC. Use the time to get organized, track every deduction, and grow your profit.

Hitting $80k+ and climbing? That’s the sweet spot where an S Corp election may finally tip the scales. Just remember: payroll, tax prep, and compliance add about $4,000 a year to your costs.

Not sure where you land? That’s where Town’s advisors can help. We’ll run the numbers side by side, check your state’s quirks, and help you figure out whether to stick with your SMLLC or pull the trigger on an S Corp.

Ready to run your own numbers? The tax team at Town can help you model the savings, navigate state rules, and make sure your S Corp election is done right the first time.

Disclaimer: This content is for educational purposes only and does not constitute personalized tax advice. Tax laws are complex and subject to change. Individual circumstances can vary significantly, and strategies that work for one taxpayer may not be suitable for another.