LLC vs S Corp: What’s the Difference and Which Saves More Tax?

An LLC is a type of business entity created under state law, while an S corporation is a federal tax status. That is why the “LLC vs S corp” question is less of an either-or choice than it first appears: an LLC can choose to be taxed as an S corp. The real decision is whether paying yourself a salary through an S corp will save enough in self-employment tax to cover the extra paperwork, payroll and state fees. This guide explains how each option works, when the S corp election tends to pay off and what US small-business owners should check before they file.

The figures below reflect 2026 rules from the Internal Revenue Service (IRS) and the Social Security Administration. Tax treatment depends on your state and personal circumstances, so treat this as a starting point for a conversation with an accountant, not as tax advice.

What Is an LLC?

A limited liability company (LLC) is a legal structure formed by filing articles of organisation with a state. Its main attraction is that it separates the business from its owners, who are called members. If the business is sued or cannot pay its debts, members’ personal assets are generally protected, provided the business is run properly and its finances are kept separate.

For federal tax purposes, the IRS does not have a separate “LLC” tax category. By default:

• A single-member LLC is treated as a “disregarded entity”, so profit is reported on the owner’s personal return, usually on Schedule C, just like a sole proprietorship.
• A multi-member LLC is treated as a partnership. It files Form 1065 and gives each member a Schedule K-1.
• Any LLC can choose to be taxed as a corporation, including as an S corporation, by filing the right election.

Under the default treatment, all of the profit flows through to the owners and is subject to income tax. Active owners also pay self-employment tax on their share. That second tax is the one the S corp election targets.

What Is an S Corporation?

An S corporation is a corporation, or an LLC, that has elected to be taxed under Subchapter S of the Internal Revenue Code. Like an LLC under default rules, it is a pass-through: the business generally pays no federal income tax itself, and profits and losses are reported on the owners’ returns through Schedule K-1. It files its own return each year on Form 1120-S.

Not every business can qualify. According to the IRS, an S corporation must:

• Be a domestic corporation or eligible entity.
• Have no more than 100 shareholders.
• Have only allowable shareholders, generally individuals, certain trusts and estates. Partnerships, corporations and nonresident aliens cannot be shareholders.
• Have only one class of stock.
• Not be an ineligible corporation, such as certain banks and insurance companies.

The nonresident alien rule matters for international founders. If you live outside the US and own a US business, you generally cannot be an S corp shareholder, so the election is off the table.

How Does the S Corp Election Save Tax?

The saving comes from the way self-employment tax works. As a sole proprietor or LLC member under default rules, you pay self-employment tax on your net earnings. The IRS rate is 15.3%: 12.4% for Social Security and 2.9% for Medicare, applied to 92.35% of net profit. The Social Security part applies only up to the annual wage base, which is $184,500 in 2026. Medicare has no cap, and an extra 0.9% applies above $200,000 for single filers. You can deduct half of the tax when you calculate your income tax.

In an S corp, the owner who works in the business becomes an employee. You pay yourself a salary that goes through payroll, with Social Security and Medicare taxes withheld and matched by the company. The remaining profit can then be paid out as distributions. Distributions are still subject to income tax, but not to Social Security and Medicare taxes.

A simplified example

Imagine a consultant with $100,000 of net profit in 2026:

• Default LLC: self-employment tax is roughly $100,000 × 92.35% × 15.3% ≈ $14,130.
• S corp with a $60,000 salary: combined employer and employee payroll tax is roughly $60,000 × 15.3% ≈ $9,180. The other $40,000 or so is a distribution, with no payroll tax.
• Gross difference: roughly $4,950 a year, before the extra costs of running an S corp.

Real numbers will differ. The company’s share of payroll tax is deductible, state taxes vary, and a lower salary can reduce your future Social Security benefits and the amount you can put into some retirement plans. The example only shows where the saving comes from.

What Is “Reasonable Compensation” and Why Does It Matter?

The obvious temptation is to pay yourself a tiny salary and take everything else as distributions. The IRS closes that door. It says S corporations must pay reasonable compensation to shareholder-employees for the services they provide before taking non-wage distributions. If the IRS decides that distributions were really disguised wages, it can reclassify them and charge back taxes, interest and penalties.

There is no fixed percentage that counts as reasonable. In practice, owners look at what the business would have to pay someone else to do the same job, taking into account their duties, hours, experience and local pay rates. Keep a short written note of how you set your salary. It is a simple step that helps if your return is ever questioned.

What Extra Costs and Paperwork Come With an S Corp?

The election is not free. Owners typically take on:

• Payroll: running real payroll, filing quarterly payroll returns and issuing yourself a W-2. Many owners pay for a payroll service.
• A separate federal return: Form 1120-S, plus K-1s, usually prepared by an accountant.
• Unemployment taxes: federal and state unemployment taxes on wages, depending on the state.
• State costs: some states charge entity-level taxes or fees. California, for example, charges LLCs an $800 annual tax, and since 2024 newly formed LLCs pay it from their first year. S corporations in California also pay a franchise tax on net income, with an $800 minimum.
• Stricter formalities: keeping business and personal money apart, paying distributions in proportion to ownership, and keeping records.

Taken together, these costs can easily run to a few thousand dollars a year. That is why accountants often say the election starts to make sense only once profit comfortably exceeds a reasonable salary for your role. Many put the rough break-even somewhere in the range of $40,000 to $80,000 of annual profit, but this is a rule of thumb rather than an official threshold.

Does the QBI Deduction Change the Decision?

The qualified business income (QBI) deduction, under Section 199A, lets many owners of pass-through businesses deduct up to 20% of their qualified business income. It is available whether you are a sole proprietor, an LLC or an S corp. The One Big Beautiful Bill Act, signed in July 2025, made the deduction permanent and added a minimum deduction of $400 from 2026 for taxpayers with at least $1,000 of QBI from businesses in which they materially participate.

There is one interaction to watch. In an S corp, the salary you pay yourself is not QBI, so a higher salary can shrink the deduction slightly. Higher earners also face limits based on wages paid and on whether the business is a “specified service” business, such as consulting, law or health. This is one reason to model both scenarios with a tax professional.

How Do You Elect S Corp Status?

An LLC or corporation elects S status by filing Form 2553, signed by all shareholders. The IRS deadline is no more than two months and 15 days after the start of the tax year in which the election is to take effect. For a calendar-year business, that usually means 15 March. You can also file at any time in the year before the election takes effect.

An LLC that files a valid Form 2553 is treated as having chosen to be taxed as a corporation, so it does not normally need to file the separate classification form, Form 8832, as well. If you miss the deadline, the IRS offers relief for late elections in many cases, provided there was reasonable cause. Check your state too, because a few states have their own S corp rules or forms.

LLC vs S Corp: Which Should You Choose?

A practical way to decide:

• Stay a default LLC if profit is modest or irregular, if you want the simplest possible set-up, or if you are not eligible (for example, as a nonresident owner).
• Consider the S corp election once profit is steady and well above a defensible salary, and you are happy to run payroll and pay for extra filings.
• Look at a C corporation instead if you plan to raise venture capital. S corps cannot have corporate or fund shareholders, or more than one class of stock, so most investor-backed startups are C corporations. Our guide to seed funding, angel investors and venture capital explains why.

Whichever route you choose, the basics still matter more than the label: a separate business bank account, clear records, money set aside for quarterly estimated tax payments, and a cash buffer. Our guide to building an emergency fund applies to businesses as well as households. If you are a freelancer weighing up platforms, see Upwork vs Fiverr.

What About Business Owners Outside the US?

The S corp is a purely US concept. In the UK, the closest comparison is between working as a sole trader and setting up a limited company, which pays corporation tax and lets directors take a mix of salary and dividends. In Canada, the equivalent decision is whether to incorporate, which can give access to the small business deduction on active business income. Australia has a similar choice between a sole trader structure, a company and a trust. The logic is similar, comparing extra admin against tax and liability benefits, but the rules are entirely different, so get local advice.

What Are the Key Takeaways?

• An LLC is a legal structure; an S corp is a tax election that an LLC can make.
• The main benefit of an S corp is lower Social Security and Medicare tax on profit paid out as distributions rather than salary.
• You must pay yourself a reasonable salary, and the IRS can reclassify distributions that look like disguised wages.
• Payroll, an extra tax return and state fees can wipe out the saving for lower-profit businesses.
• Form 2553 is generally due by 15 March for calendar-year businesses.
• Investor-backed startups usually need a C corporation instead.

This article is general information and not tax or legal advice. Rules change and depend on your state, so speak to a qualified accountant or tax adviser before you file an election.

Featured image: Broad Street storefronts in Waterford, New York, by Tyler A. McNeil / Wikimedia Commons, CC BY-SA 4.0. Cropped, colour-graded and combined with MediaPavilion branding.

Sources

• Internal Revenue Service — S corporations (accessed 25 October 2026).
• Internal Revenue Service — Instructions for Form 2553 (accessed 25 October 2026).
• Internal Revenue Service — Limited liability company (LLC) (accessed 25 October 2026).
• Internal Revenue Service — Topic no. 554, Self-employment tax (accessed 25 October 2026).
• Social Security Administration — Contribution and benefit base (accessed 25 October 2026).
• Internal Revenue Service — S corporation employees, shareholders and corporate officers (accessed 25 October 2026).
• Internal Revenue Service — Qualified business income deduction (accessed 25 October 2026).
• Legal Information Institute (Cornell Law School) — 26 U.S.C. § 199A: Qualified business income (accessed 25 October 2026).
• California Franchise Tax Board — Limited liability company (accessed 25 October 2026).
• US Small Business Administration — Choose a business structure (accessed 25 October 2026).