S-corp election, rebuilt for owners who take a paycheck
For the right business at the right revenue, S-corp is still the cleanest way to lower your effective tax rate. The hard part is setting reasonable comp.
Almost every small-business owner who crosses $60,000 in net profit eventually asks the same question: should I be an S-corp? The answer, for the right kind of business, has not changed in twenty years. The execution has, and that is what trips owners up.
The S-corp election is a tax classification, not an entity. Your LLC stays an LLC; your contracts do not change; your bank account does not move. What changes is how the IRS taxes the money flowing through it.
What the math actually says
A single-member LLC taxed as a sole proprietor pays self-employment tax on every dollar of net profit — 15.3% on the first $168,600 this year, then 2.9% above that, plus the Additional Medicare Tax over the high-earner thresholds. The S-corp election lets the same dollars be split between W-2 wages (which carry the same payroll tax) and distributions (which do not).
The savings come from the distribution portion. If your salary is $80,000 and your distributions are $80,000, you save the 15.3% payroll tax on the second $80,000 — about $12,000 a year. Subtract the payroll-processing cost, the additional return filing (Form 1120-S), the unemployment insurance, and the cost of running it correctly. What is left is the real savings number, usually $7,000 to $10,000 a year for owners in the $150K–$250K profit range.
An S-corp is not a way to pay yourself less. It is a way to characterize the same dollars differently — and the IRS knows that.
The “reasonable compensation” question
This is where most owners stumble. The IRS does not give you a formula. It gives you a set of factors: training and experience, duties and responsibilities, time and effort, comparable salaries in your industry and geography, what an unrelated third party would pay for the same work. You build a number from those, you document it, and you defend it if asked.
Three rules of thumb that hold up under audit:
- Below the Social Security wage base, be generous. If your reasonable salary is $90,000, paying $50,000 is conspicuous.
- Above the wage base, the audit risk drops. The IRS cares about Social Security and Medicare tax leakage. Once you have paid those in full on a credible salary, the rest of the math gets quiet.
- Document the comparable. A simple memo to the file citing two or three salary surveys for your role in your market is the difference between defending the number in an hour and defending it in a year.
Who should not elect
A few categories of business should leave the S-corp election alone, at least for now.
If your net profit is under about $50,000, the operational cost of running payroll, filing the 1120-S, and reconciling owner draws against payroll usually eats the savings. If your business has multiple owners with different active-participation profiles, the W-2 salaries can become a political problem before they become a tax problem. And if you anticipate raising outside investment, the S-corp election creates real friction with most institutional investors and several states.
What we tell clients
For most service-business owners between $150,000 and $400,000 in profit, the S-corp election still earns its keep. We model the savings, document the reasonable-comp number, file the 2553 (or the late-election relief request if the calendar has gotten away from you), and set up payroll the same week. If you’d like to see what the numbers look like for your situation, book a 30-minute call and bring last year’s return.
