LLC vs. S-Corp for Contractors: The Entity Choice That Saves (or Costs) $15K a Year

The Self-Employment Tax Problem With LLCs

When you operate as a single-member LLC (or a sole proprietor), the IRS treats your business income as self-employment income. This means you pay:

• Social Security tax: 12.4% on net self-employment income up to $176,100 (2025 wage base)
• Medicare tax: 2.9% on all net self-employment income (no cap)
• Additional Medicare tax: 0.9% on income over $200,000 (single filers) or $250,000 (married filing jointly)
• Total SE tax: 15.3% up to the wage base, then 2.9% (plus 0.9% above the thresholds)

You do get to deduct half of your SE tax as an income tax deduction, which softens the blow somewhat. But on $200,000 of net income, you're still paying approximately $24,000–$27,000 in SE tax. A significant portion of this can be legally avoided through an S-Corp election.

How an S-Corp Saves on SE Tax

An S-Corporation is a pass-through entity—income flows through to shareholders' personal returns. But unlike an LLC, an S-Corp requires owner-employees to pay themselves a reasonable salary. Here's how the tax treatment differs:

• Salary: Subject to FICA taxes (Social Security + Medicare) at the same rates as SE tax—split between employee and employer portions
• Distributions: The profit above the salary flows to shareholders as distributions—not subject to FICA or SE tax

The savings come entirely from the distributions. Every dollar you can legitimately pay yourself as a distribution (above a reasonable salary) avoids the 15.3% SE/FICA tax. On $100,000 in distributions, that's $15,300 saved. On $150,000 in distributions, that's $22,950 saved.

The Math: LLC vs. S-Corp at Different Income Levels

*S-Corp SE tax assumes $80,000 reasonable salary. Actual savings vary based on salary level and state taxes.

At $75,000 in profit, the savings (~$2,100) barely offset the additional costs of running an S-Corp. At $125,000, you're in the range where it starts to clearly make sense. At $200,000+, the case is overwhelming.

The Reasonable Salary Requirement

The IRS requires S-Corp owner-employees to pay themselves a "reasonable salary" for services performed. This is the most scrutinized aspect of S-Corp tax planning, and getting it wrong can result in the IRS reclassifying your distributions as wages and assessing back payroll taxes plus penalties.

How is "reasonable" determined? The IRS looks at:

• What a similarly experienced employee would earn for the same role in your market
• Industry wage data (BLS data is commonly referenced)
• The ratio of salary to total distributions (extremely low salaries are a red flag)
• The services actually performed and time devoted to the business

For a contractor, reasonable salaries typically range from $60,000 to $100,000 depending on specialty, experience, and market. A plumbing contractor running a $500K revenue business might justify an $85,000 salary. The remaining $150,000+ can flow as distributions.

The Costs and Complexity of an S-Corp

Running an S-Corp is more complex than a simple LLC. Here's what you're taking on:

• Payroll setup and ongoing payroll taxes: You need a payroll provider (Gusto, ADP, etc.) and must file quarterly payroll returns (941s) and annual W-2s
• Separate S-Corp tax return (Form 1120-S): This is filed in addition to your personal return, typically costing $500–$1,500 more in tax preparation fees
• State requirements: Most states have annual registration fees, annual reports, and their own S-Corp rules
• Higher accounting costs: Budget approximately $2,000–$4,000 per year in additional administrative costs
• More rigorous bookkeeping: S-Corps require cleaner books because of the payroll and distribution tracking

At $150,000 in net profit, you might spend $3,000 more per year to operate as an S-Corp and save $10,000+ in SE tax. Net benefit: $7,000+. At $200,000, the numbers are even better. For more on bookkeeping best practices that support an S-Corp structure, see our guide to business bookkeeping.

When S-Corp Doesn't Make Sense

S-Corp election is not right for everyone. Consider staying as an LLC if:

• Net profit is below $50,000: The savings don't justify the additional complexity and costs
• Income is highly variable: If you have unpredictable swings in revenue, the payroll requirement can be burdensome in slow years
• You're planning to sell the business soon: S-Corp vs. LLC can have different implications for business sales depending on structure
• You have significant losses: S-Corp losses pass through to shareholders but have basis limitations; LLC losses may flow more cleanly in some situations
• You're in a state with heavy S-Corp taxes: Some states impose their own S-Corp fees or minimum taxes that reduce the benefit

How to Make the S-Corp Election

If you've decided an S-Corp makes sense for your situation, here's how to proceed:

1. Confirm you meet the eligibility requirements (domestic corporation or LLC, one class of stock, no more than 100 shareholders, all shareholders must be US citizens/residents)
2. File IRS Form 2553 (Election by a Small Business Corporation) by March 15 for current-year treatment, or within 75 days of forming your entity
3. Set up a payroll system and begin paying yourself a reasonable salary starting from the election date
4. Open a separate business bank account if you haven't already—commingling funds is a problem with S-Corps
5. Engage a CPA familiar with S-Corp requirements to handle the Form 1120-S annual return
6. Keep accurate records of distributions vs. salary for each year

The entire process, from decision to active S-Corp, typically takes 4 to 8 weeks. The March 15 deadline is firm for current-year treatment—missing it means waiting until January of next year to start saving. Don't let another year pass as an LLC if the numbers support making the switch. For a broader look at tax planning strategies for small businesses, including entity selection, see our full guide.

Frequently Asked Questions