LLC vs S Corp: What Actually Changes
LLC and S corp are not competing entity types, and the comparison confuses people because it is usually framed as though they were. An LLC is a legal structure; an S corporation is a tax election that an LLC can make while remaining an LLC. The real question is not which to choose but whether to elect.
What the election changes is how profit is taxed. What it does not change is your liability protection, your operating agreement, or your state registration.
LLC (default taxation) vs S corporation election: Side-by-Side
| LLC (default taxation) | S corporation election | |
|---|---|---|
| What it is | A legal entity formed with the state | A tax election made with the IRS on Form 2553 |
| Liability protection | Yes, from the LLC itself | Unchanged — it comes from the LLC, not the election |
| How profit is taxed | All net profit subject to 15.3% self-employment tax (on 92.35%) | Payroll tax on the salary only; distributions escape it |
| Owner pay | Owner's draw — no payroll needed | W-2 salary that must be 'reasonable', plus distributions |
| QBI deduction | Full profit is qualified business income | Reduced — wages are not QBI, so salary shrinks the §199A base |
| Tax return | Schedule C with your personal return | Separate Form 1120-S plus a K-1 to yourself |
| Ongoing cost | None beyond your usual return | Payroll service + extra return, typically several hundred to $2,000/yr |
| Social Security credits | Based on all net earnings | Based on salary only — a lower salary lowers your benefit base |
| Audit exposure | Standard | Reasonable compensation is an examined issue with case law behind it |
| Where it pays | Lower profit, or where a defensible salary is close to all profit | Higher profit with room between a defensible salary and total profit |
Which should you choose?
Stay with default LLC taxation until the numbers clearly justify the election, and judge them on the net saving rather than the payroll tax avoided. Holding salary at half of profit, an S election clears $1,000 a year of net benefit at around $35,000 of profit; at a more conservative 60% salary the threshold rises to roughly $52,000. At $120,000 of profit with a $60,000 salary it saves about $4,171 a year.
Elect when there is genuine room between a defensible salary and your total profit — which usually means the business earns meaningfully more than the market rate for the work you personally do. If your revenue is entirely your own billable hours, that room may never open, and the election can cost money: at $90,000 of profit with a $70,000 salary it runs $1,530 a year in the wrong direction.
They are not alternatives — one sits inside the other
An LLC is formed with your state and gives you a legal entity separate from yourself, which is where liability protection comes from. S-corp status is an election made with the IRS that changes how that entity's profit is taxed. An LLC can elect it and stay an LLC in every legal respect.
This matters practically because the choice is not exclusive and not permanent in the way people assume. You do not give up an LLC to become an S-corp, and you do not need to form a corporation. Most one-person businesses that elect S-corp status are LLCs that filed Form 2553 — the operating agreement, the state filing, and the liability shield are untouched.
What the election actually saves, and what it costs
Under default taxation, all of an LLC's profit is subject to self-employment tax. Under an S election, only the salary is subject to payroll tax; the distribution is not. That is the saving, and it is real.
Two costs come off it. The qualified business income deduction applies to pass-through profit, and wages are not qualified business income — so every dollar routed into salary removes a dollar from the §199A base. At $120,000 of profit with a $60,000 salary, the election avoids $7,775 of payroll tax but forfeits $8,242 of QBI deduction. And payroll is not free: a payroll service plus the separate Form 1120-S recurs every year, in lean years as well as good ones.
The net figure at that profit is $4,171 — worth having, but 46% below the gross payroll tax saved. Run your own numbers in the LLC vs S corp tax calculator.
The salary is the constraint, not the profit
The election's benefit is the gap between your total profit and the salary you can defend, so the salary decides everything. The IRS requires reasonable compensation for services before non-wage distributions are made, and it publishes no safe harbor and no percentage. The 60/40 and 2% rules circulating online are not IRS positions.
What the IRS examines is where the corporation's gross receipts come from. Receipts generated by the shareholder's own services should be paid as wages. That is why a consultant billing their own time has little room, while an owner whose revenue is produced by employees and equipment has considerably more. Judge the election against a salary you would be comfortable defending, not the lowest one a calculator will accept — see the reasonable salary calculator.
The costs that are not on the tax return
Three consequences get left out of most comparisons. Social Security benefits are computed from your earnings record, and only wages count — a lower salary lowers the earnings on record and eventually the benefit. Personal borrowing can get easier, since lenders underwrite a W-2 more readily than a Schedule C. And several states tax S corporations directly or charge franchise fees, which can erase a modest federal saving outright.
There is also an administrative floor. Payroll means real deadlines: withholding, remitting, and filing employment tax returns on time, every quarter, whether or not the business is having a good month. For some owners the recurring obligation is a larger cost than the dollar figure suggests.
How to make the election if the numbers work
The election is made on Form 2553, and the timing is strict: no more than two months and 15 days after the beginning of the tax year it is to take effect, or at any point in the preceding tax year. Miss it and the election applies to the following year instead.
Late-election relief exists under Rev. Proc. 2013-30 where the failure was due to reasonable cause, the corporation intended S status from the effective date, and Form 2553 is filed within three years and 75 days of it, with "FILED PURSUANT TO REV. PROC. 2013-30" written at the top. It is available, but it is not a plan.
Frequently asked questions
Is an LLC or S corp better?
The question is slightly wrong, because an S corp is a tax election an LLC can make rather than a competing entity. Default LLC taxation is better at lower profit: it costs nothing extra and preserves the full QBI deduction. An S election is better once there is real room between a defensible salary and total profit — roughly from $35,000 of profit at a 50% salary, or $52,000 at a 60% salary.
Who pays more taxes, an LLC or an S corp?
At the same profit, an S corp usually pays less overall, but by less than the headline suggests. At $120,000 of profit with a $60,000 salary, default LLC taxation costs $28,462 in federal tax while the S-corp route costs $24,291 including payroll costs — a $4,171 difference. Set the salary conservatively enough and the S corp pays more: at $90,000 of profit with a $70,000 salary it costs $1,530 extra.
At what income should I switch from LLC to S corp?
There is no universal number, because it depends on the salary you can defend rather than on revenue. Holding salary at half of profit, the net saving clears $1,000 a year at around $35,000 of profit; at 60% it takes about $52,000. Add state franchise or S-corp taxes and the practical threshold rises further. If your revenue is entirely your own billable time, the election may never pay.
Does an S corp give more liability protection than an LLC?
No. Liability protection comes from the legal entity — the LLC or corporation — not from the tax election. An LLC that elects S-corp treatment has exactly the protection it had before. Anyone selling an S election on the basis of stronger liability protection is describing something the election does not do.
Can I undo an S corp election?
You can revoke it, but not casually. A revocation generally takes effect at the start of a tax year if filed early enough, and after terminating an election a corporation usually must wait five years before electing again without IRS consent. Because the decision is sticky, it is worth being confident the saving is durable rather than a one-off good year.
Do I need an LLC to elect S corp status?
You need an eligible entity, which in practice means an LLC or a corporation — you cannot elect S-corp status as a sole proprietor. For a one-person business the usual path is to form an LLC and then file Form 2553, which keeps the simpler LLC formalities while changing the tax treatment.
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Sources
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