Choosing the right entity structure can save thousands in taxes. Here is a plain-English breakdown of the options.
This is one of the most common questions I get from small business owners, and for good reason. The right entity structure can save you thousands of dollars every year. The wrong one can cost you just as much.
Here is how to think through it.
When you earn net profit as a sole proprietor or single-member LLC, all of it is subject to self-employment tax. For 2025, that is 15.3 percent on the first $176,100 of net earnings and 2.9 percent above that. On $100,000 of net profit, self-employment tax alone is about $14,130. That is a significant number, and it is the core of what entity structure planning addresses.
An S-Corp does not eliminate self-employment tax. What it does is restructure how your income is classified. As an S-Corp owner-employee, you pay yourself a reasonable salary. That salary is subject to payroll taxes, which are essentially the equivalent of self-employment tax. But profit above your salary can be distributed to you as an S-Corp distribution, and distributions are not subject to payroll taxes.
A simple example makes this clear. Say your business nets $150,000. As a sole proprietor, you pay self-employment tax on all $150,000. As an S-Corp, you pay yourself a $90,000 salary and take $60,000 as a distribution. You pay payroll taxes on the $90,000 but not on the $60,000 distribution. The payroll tax savings on that $60,000 is roughly $9,180 per year. In many cases, that exceeds the administrative cost of running an S-Corp.
The IRS requires that owner-employees pay themselves a reasonable salary for services rendered. Setting an artificially low salary to maximize distributions is a known audit trigger. A CPA can help you determine what is defensible based on your industry, role, and market.
The S-Corp election generally makes sense when your net business profit consistently exceeds $40,000 to $50,000 per year. Below that threshold, the administrative costs, which include payroll processing, additional tax filings, and state fees, often outweigh the tax savings. Above $50,000 in net profit, the math starts to favor the S-Corp election. At $100,000, the annual savings can exceed $5,000. At $200,000, it can exceed $12,000.
One more thing worth knowing: an LLC and an S-Corp are not mutually exclusive. The most common structure for profitable small businesses is an LLC that has elected to be taxed as an S-Corp. You get the liability protection of the LLC with the payroll tax savings of the S-Corp election.
State rules matter too. Some states impose additional fees or taxes on S-Corps that can offset the federal savings. That analysis needs to be run for your specific state before making any decision.
When an S-Corp makes sense
The S-Corp election typically makes sense when net business profit exceeds $40,000 to $50,000 annually. Below that threshold, the administrative costs of running an S-Corp — payroll processing, additional tax filings, state fees — often exceed the tax savings.
Above $50,000 in net profit, the math generally favors an S-Corp election. At $100,000 in net profit, the annual tax savings can exceed $5,000. At $200,000, savings can exceed $12,000.
LLC vs S-Corp: the key distinctions
An LLC is a state law entity that provides liability protection. For federal tax purposes, a single-member LLC is treated as a sole proprietorship by default, and a multi-member LLC is treated as a partnership. An LLC can elect to be taxed as an S-Corp by filing Form 2553.
The most common structure for profitable small businesses is an LLC that has elected S-Corp tax treatment — you get the liability protection of the LLC with the tax advantages of the S-Corp.
State considerations
Some states impose additional franchise taxes or fees on S-Corps that can offset the federal tax savings. California, for example, imposes a 1.5% franchise tax on S-Corp net income with a minimum of $800. Your CPA should run the analysis for your specific state before recommending the election.
Getting the analysis done right
Entity structure decisions have long-term consequences and should be made with a CPA who runs the numbers for your specific income level, state, and business structure. At SureEdge Tax & Accounting, we provide entity structure analysis as part of our business consulting services. Contact us to discuss whether an S-Corp election makes sense for your business.