Should Your LLC Be Taxed as an S Corporation?

An LLC and an S Corp are not the same thing

This is where most of the confusion starts. An LLC is a legal structure created at the state level — it defines liability and ownership. An S Corporation is a federal tax election that changes how the business's income is taxed. An LLC can elect to be taxed as an S Corp, but the two labels describe different things.

By default, a single-member LLC is taxed as a sole proprietorship and a multi-member LLC as a partnership. In both cases, the owner generally pays self-employment tax on the full net profit of the business. The S Corp election changes that calculation.

Where the potential savings come from

When an LLC is taxed as an S Corp, the owner who works in the business becomes an employee and is paid a salary through payroll. Remaining profit can then be taken as a distribution. Salary is subject to payroll taxes; distributions generally are not subject to self-employment tax.

That split is the entire source of the potential savings. But it only works if there is enough profit above a reasonable salary to make the distribution meaningful — and if the salary itself is set correctly.

Reasonable compensation is not optional

The IRS requires S Corp owners who work in the business to pay themselves reasonable compensation — roughly what someone would be paid to do the same work elsewhere. Setting an artificially low salary to shift more income into distributions is a well-known audit risk.

This is why revenue alone cannot answer the question. Two businesses with the same revenue can land in very different places depending on their profit margins and what a reasonable salary looks like for the work involved.

The costs that offset the benefit

An S Corp is more expensive and more involved to run than a default LLC. Before assuming it saves money, weigh the ongoing costs:

• Running formal payroll for the owner, including payroll tax filings.
• A separate business tax return (Form 1120-S) in addition to the personal return.
• More detailed bookkeeping and, often, higher accounting fees.
• Possible state-level fees or franchise taxes on the entity.

For a business with modest profit, those costs can erase most or all of the tax benefit. For a business with steady, higher profit above a reasonable salary, the math can look very different.

So — should your LLC be taxed as an S Corp?

It depends on the full picture: profit after a reasonable salary, the cost of running payroll and extra filings, state rules, and where the business is heading. An S Corp election can be a genuinely valuable strategy — or an expensive complication that does not fit the situation.

The right way to decide is to run the actual numbers for the business rather than relying on a revenue rule of thumb. That is exactly the kind of question worth reviewing before an election is filed.