S corporation or LLC? The question has a wrong premise, and the answer is a number

"Should I be an S corp or an LLC?" is one of the most common questions a small business owner asks, and it is built on a mix-up. The two are not alternatives on the same menu. One is a legal entity your state creates. The other is a tax election you make with the IRS. Plenty of businesses are both at once.

Once that is untangled, the real question gets much smaller: is the tax you would save worth the payroll you would have to run?

Two different things

An LLC is a legal entity. You form it with your state. It is what separates your business's debts and lawsuits from your house and your savings. It says nothing, by itself, about how you are taxed.

An S corporation is a tax status. It is an election made on IRS Form 2553, and it changes how the business's profit is taxed at the federal level. It says nothing about liability — that protection comes from the entity underneath, whether that is an LLC or a corporation.

So the choices are really these:

An LLC that elects S status keeps its LLC — the same state registration, the same liability shield, the same operating agreement. Only the federal tax treatment changes. And an LLC that files a valid Form 2553 does not also need Form 8832, the IRS's separate classification election; the S election covers it.

The one difference that drives most decisions: self-employment tax

As a single-owner LLC taxed the default way, your whole profit is self-employment income. Self-employment tax is 15.3% — 12.4% for Social Security and 2.9% for Medicare — applied to 92.35% of your net earnings. The Social Security part stops at the yearly wage base, which is $184,500 for 2026. Medicare has no ceiling.

An S corporation changes the shape of that. The business pays you a salary, and the salary carries the same 15.3%, split between you and the company as ordinary payroll tax. What is left after the salary can come out as a distribution, and distributions carry no Social Security or Medicare tax at all.

That is the whole attraction, and it is real. Here it is on one business:

$120,000 of profit, one owner, all of it from the owner's own work.

That is federal payroll tax only, before any of the costs below, and before income tax — which is the subject of the next section.

The catch the arithmetic depends on: "reasonable compensation"

Look at the table again and the obvious question is: why not pay a $20,000 salary and take $100,000 as distributions?

Because the IRS says you cannot. An S corporation must pay reasonable compensation to a shareholder who works in the business before it takes money out as distributions. Where the profit comes from your personal services, the IRS can reclassify distributions as wages and collect the payroll tax on them.

What counts as reasonable is a judgment, not a formula. The IRS lists what it looks at: your training and experience, your duties, the time you put in, what comparable businesses pay for similar work, and the company's dividend history. A salary well below what you would have to pay someone else to do your job is the pattern that gets questioned.

So the saving is not "S corp versus LLC". It is the profit above a defensible salary, times the payroll tax rate. If your profit is not much above what a fair salary for your work would be, there is nothing left to save.

What you give back

A smaller qualified business income deduction. Owners of LLCs and S corporations can deduct up to 20% of qualified business income on their own returns, and the 2025 tax law made that deduction permanent. But the IRS is explicit that "amounts received as reasonable compensation from an S corporation" are not qualified business income. Your salary shrinks the base. In the example above, at a 22% income tax bracket, that gives back roughly $2,900 of the $6,245 — close to half. The exact figure depends on your bracket and on limits we have left out, which is exactly why it is worth having it calculated rather than estimated.

Payroll, permanently. Running a salary means quarterly Form 941, annual Form 940 for federal unemployment tax, W-2s, deposits on the IRS's schedule, and state payroll registrations. That is either a payroll service or your own time, every pay period, for as long as the election stands.

Another return. The S corporation files its own Form 1120-S with a K-1 for each owner, due on the 15th day of the third month after the year ends — March 16, 2026 for calendar-year 2025, because March 15 fell on a Sunday. Filing it late costs $255 per shareholder for each month, up to twelve months, even when no tax is owed.

Your state. States do not all treat S corporations the same way, and some charge the S corporation its own tax or fee. Check yours before the federal saving looks final.

The rules an S corporation has to keep

• No more than 100 shareholders.
• Only allowed shareholders: individuals, certain trusts and estates. No partnerships, no corporations, and no nonresident aliens. If a foreign partner or an investment company might ever own part of the business, an S corporation is the wrong home for it.
• One class of stock. Every owner's share of distributions has to follow their ownership. An LLC taxed as a partnership can split profit however its operating agreement says; an LLC taxed as an S corporation cannot.
• A domestic company, and not one of the excluded kinds, such as certain banks and insurance companies.

When to file the election

Form 2553 has to be filed no more than 2 months and 15 days after the start of the tax year it should apply to, or at any point in the year before. Every shareholder signs it. Miss the window and the election normally starts the following year. There is a relief procedure for late elections with reasonable cause, but it is a repair, not a plan.

So which is it?

• Starting out, or profit close to what a fair salary would be: an LLC taxed the default way. Simple, cheap to run, nothing to give back.
• Profit comfortably above a defensible salary, and you are willing to run payroll: an LLC taxed as an S corporation is worth calculating. Calculate it with the deduction you lose and the costs you add, not with the payroll tax alone.
• Partners abroad, outside investors, or profit split differently from ownership: the S corporation's rules are likely to rule it out before the tax does.

Make it with the numbers in front of you. This is a decision a CPA or an enrolled agent should check against your own figures. We are neither, and this guide is not tax advice.

Where we fit, and where we do not

Our books follow either choice. A US company here gets an American chart of accounts in dollars, with separate lines for the employee and employer shares of Social Security and Medicare. That makes the salary and the distributions in the comparison above two different entries rather than one.

What we do not do, plainly:

• We do not run US payroll. There are accounts to post a salary to, but nothing here calculates withholding or files a 941. An S corporation needs a payroll provider alongside us.
• We do not file Form 1120-S, 1065 or 2553, and we do not tell you whether to make the election.
• We are not a CPA firm.

Sources, read 21 October 2026: the IRS pages on S corporations, S corporation compensation, limited liability companies, self-employment tax and the qualified business income deduction; the instructions for Forms 2553 and 1120-S; Topic 554 on self-employment tax; and the Social Security Administration's 2026 cost-of-living release for the wage base.