Contents
1) What changes when you elect S-Corp status
An LLC is a legal structure. Taxation is a separate choice. A single-member LLC is often taxed as a “disregarded entity” and a multi-member LLC is often taxed as a partnership. An S-Corp election changes the tax treatment so that an owner who works in the business is typically treated as a shareholder-employee.
What you gain
- • Potential reduction in self-employment-style taxes on part of profit
- • Clear split between salary and distributions
- • Sometimes cleaner bookkeeping around owner pay
What you take on
- • Payroll setup + ongoing filings
- • Need to defend “reasonable compensation”
- • Separate business tax return (1120-S) and related admin
2) LLC vs S-Corp: quick comparison
| Topic | LLC (default taxation) | S-Corp election |
|---|---|---|
| Owner pay | Owner draws / allocations | W-2 salary + distributions |
| Payroll requirement | Usually none for owners | Yes (if owner provides services) |
| SE/payroll taxes | Often applies broadly to active income | Applies to salary; distributions typically not SE-taxed |
| Admin complexity | Lower | Higher (payroll + 1120-S) |
| Audit risk driver | Misclassification of income, documentation gaps | Unreasonably low salary vs distributions |
3) Reasonable compensation (in practice)
The core idea: if you materially work in the S-Corp, you can’t treat all profits as distributions. You generally need a salary that matches the market value of your services.
A defensible approach
- • Document your role (sales, delivery, ops, admin) + hours
- • Benchmark comparable pay (industry, location, seniority)
- • Revisit annually as profit and duties change
4) QBI (199A): the “hidden” interaction
Many owners focus only on payroll tax savings, but the QBI deduction can shift when you change the mix of salary vs pass-through profit. This is one reason the “best” salary isn’t always “as low as possible.”
Why it matters
Increasing W-2 wages can reduce pass-through profit, which may reduce the base for certain deductions.
Practical takeaway
Model the scenario with your CPA: total tax is what counts (income tax + payroll/SE tax + state).
5) Common pitfalls (and how to avoid them)
Pitfall: near-zero W-2 wages
Large distributions with tiny wages are a red-flag pattern. Use a documented wage methodology.
Pitfall: ignoring fringe benefit rules
Certain benefits (like health insurance handling for >2% shareholders) often need specific reporting mechanics.
Pitfall: choosing S-Corp too early
If profits are modest, payroll + compliance costs can eat most (or all) of the benefits.
FAQ
Is an S-Corp “better” than an LLC? ▾
Not automatically. It depends on profit, your role in the business, and whether payroll/compliance costs are worth it.
Can I take only distributions in an S-Corp? ▾
If you work in the business, you generally need W-2 wages that reflect reasonable compensation.
What’s the simplest next step? ▾
Ask your CPA to model total tax under both setups using your expected profit and a defensible salary range.