Every year, thousands of business owners get the same advice: “You need to elect S Corp status. You’re leaving money on the table.” And every year, a good chunk of them spend more on compliance than they ever save in taxes.
That does not mean S Corp elections are bad. It means the analysis is more nuanced than a TikTok accountant would have you believe. Let’s walk through how each business structure actually gets taxed, what it costs to maintain, and when the math actually works in your favor.
How Sole Proprietors and Single-Member LLCs Get Taxed
If you run a business as a sole proprietor or a single-member LLC (which the IRS treats as a “disregarded entity”), your business income flows directly onto your personal tax return on Schedule C. There is no separate business tax return.
You pay two types of federal tax on that income:
1. Self-Employment Tax
Self-employment (SE) tax is the self-employed person’s version of FICA (Social Security and Medicare). When you work for an employer, you split FICA with them: you each pay 7.65%. When you work for yourself, you pay both halves: 15.3%.
Here is how it breaks down for 2025:
- Social Security: 12.4% on the first $176,100 of net self-employment earnings
- Medicare: 2.9% on all net self-employment earnings (no cap)
- Additional Medicare Tax: 0.9% on earnings above $200,000 (single) or $250,000 (married filing jointly)
A couple of important details most people miss:
You do not pay SE tax on 100% of your net income. The IRS lets you calculate SE tax on 92.35% of your net self-employment income. This is meant to approximate the fact that an employer would pay half of FICA, and that half would not be part of your income.
Half of your SE tax is deductible. You get to subtract the “employer equivalent” portion (half of your total SE tax) from your adjusted gross income. This reduces your income tax.
2. Income Tax
Your net business income (after the above-the-line deduction for half of SE tax) is added to any other income you have and taxed at ordinary income tax rates. For 2025, federal rates range from 10% to 37%.
The QBI Deduction (Section 199A)
If you qualify, you can also deduct 20% of your qualified business income (QBI) from your taxable income. This is a significant benefit that reduces your effective tax rate.
For sole proprietors, QBI is generally your net Schedule C income minus the deductible half of SE tax and any deductible contributions to self-employed retirement plans.
The QBI deduction has limitations for higher earners and for “specified service trades or businesses” (think lawyers, doctors, consultants, accountants). Above certain income thresholds ($191,950 for single filers, $383,900 for MFJ in 2025), the deduction starts to phase out or becomes subject to W-2 wage and property limitations.
Below those thresholds, the math is straightforward: you deduct 20% of QBI from your taxable income, capped at 20% of your overall taxable income.
How an S Corp Election Changes Things
An S Corp is not a different type of entity. It is a tax election. You can be an LLC that elects S Corp tax treatment by filing Form 2553 with the IRS. You are still an LLC under state law. The change is purely in how the IRS treats your income for tax purposes.
Here is the key difference: as an S Corp owner-employee, you split your business income into two buckets.
Bucket 1: Salary (W-2 Wages)
You pay yourself a “reasonable salary” as an employee of the S Corp. This salary is subject to full FICA taxes, just like any other W-2 job:
- Employee share: 7.65% (6.2% Social Security + 1.45% Medicare)
- Employer share: 7.65% (6.2% Social Security + 1.45% Medicare)
- Total: 15.3% on salary up to the Social Security wage base ($176,100 for 2025)
- Above the wage base: 2.9% Medicare only
- Additional Medicare Tax of 0.9% applies on wages above $200,000 (single) / $250,000 (MFJ)
The employer portion is a deductible business expense for the S Corp.
Bucket 2: Distributions (Profit Distributions)
Whatever profit remains after paying your salary (and other business expenses) can be distributed to you as an owner. These distributions are:
- Not subject to FICA taxes. This is the whole point.
- Subject to ordinary income tax.
- Eligible for the Section 199A QBI deduction (the salary portion is not QBI; the distribution portion is).
Where the Savings Come From
The tax savings from an S Corp election come entirely from avoiding the 15.3% FICA tax on the distribution portion of your income. If your business earns $200,000 and you pay yourself an $80,000 salary, the remaining $120,000 in distributions avoids roughly $18,360 in FICA taxes (before considering the SE tax calculation nuances and caps).
That looks great on paper. But it is not the whole picture.
The Hidden Costs Nobody Talks About
Here is where the “just elect S Corp” advice falls apart for a lot of people. The S Corp election comes with real, ongoing costs that directly reduce (and sometimes eliminate) those FICA savings.
1. An Additional Tax Return ($1,000 - $3,000+/year)
As a sole proprietor, your business income goes on Schedule C of your personal return. Simple-ish.
As an S Corp, you must file a separate Form 1120-S (the S Corp return) in addition to your personal return. The S Corp return generates Schedule K-1s for each shareholder. Your CPA now has two returns to prepare, and the corporate return is more complex. Expect to pay $1,000 to $3,000 more per year in tax preparation fees, depending on your market.
2. Payroll Setup and Ongoing Costs ($500 - $2,400+/year)
You are now an employer. That means:
- Registering for federal and state employer tax accounts
- Running payroll (at minimum, for yourself)
- Filing quarterly payroll tax returns (Form 941)
- Filing annual W-2s and W-3
- Paying federal and state unemployment taxes (FUTA/SUTA)
- Subscribing to a payroll service (Gusto, ADP, etc.) or paying your CPA to run payroll
Payroll services typically run $40 to $200 per month for a single employee. That is $480 to $2,400 per year before you count potential setup fees.
3. Reasonable Compensation Risk
The IRS requires that S Corp owner-employees pay themselves a “reasonable salary” before taking distributions. There is no bright-line rule for what “reasonable” means, but the IRS has won cases where owners paid themselves unreasonably low salaries to minimize FICA.
If the IRS reclassifies your distributions as wages, you owe back FICA taxes plus penalties and interest. The audit risk is real, and it is the primary enforcement focus for S Corp returns.
This means you cannot just pay yourself $20,000 and take $180,000 in distributions. A reasonable salary for most professionals is typically 40% to 60% of net business income, though the analysis depends on your industry, your role, your risk tolerance, and comparable compensation data.
4. Bookkeeping Burden
S Corps require more formal bookkeeping:
- Maintaining a separate corporate bank account (you should already have this as an LLC, but many sole proprietors do not)
- Tracking shareholder basis
- Maintaining corporate minutes and records
- Properly documenting salary vs. distributions
- More complex year-end accounting
If you were doing your own books as a sole proprietor, you may now need a bookkeeper. That is another $200 to $500 per month. This is a cost you should already be doing, so it’s really not fair to knock it as a new cost, but it is a cost that many people ignore when they do the S Corp math.
5. State-Level Complications
Many states impose their own taxes and fees on S Corps. Depending on your state, the S Corp election could actually increase your total tax burden. I’m not going to get into this here.
6. Adding It Up
Here is a realistic estimate of annual S Corp compliance costs for a single-owner business:
| Cost | Low Estimate | High Estimate |
|---|---|---|
| Additional CPA fees (1120-S + K-1) | $1,000 | $3,000 |
| Payroll service | $500 | $2,400 |
| Additional bookkeeping | $0 | $3,000 |
| State fees/taxes | $0 | $1,500 |
| Total | $1,500 | $9,900 |
For most single-owner businesses, expect to spend $3,000 to $6,000 per year in additional costs that you would not have as a sole proprietor.
When Does the S Corp Actually Make Sense?
The break-even point depends on your income level, your reasonable salary, and your actual compliance costs. But here is the general picture:
Below $60,000 net income: Almost never worth it. Your FICA savings are minimal, and compliance costs will likely exceed them.
$60,000 to $100,000 net income: Maybe. The savings might be $2,000 to $5,000, but after $3,000 to $5,000 in compliance costs, you are close to break-even. You are adding a lot of complexity for little or no net benefit.
$100,000 to $200,000 net income: This is where it starts to make real sense for most people. FICA savings of $5,000 to $15,000 can meaningfully outpace compliance costs.
Above $200,000 net income: Almost always worth it (assuming you are in a pass-through business). The FICA savings become substantial, and the compliance costs become a smaller percentage of the total benefit.
Run the Numbers Yourself
We built a free calculator that lets you plug in your actual income, salary, filing status, and compliance costs to see exactly how the three structures compare for your situation. It includes charts across income levels and a break-even analysis.
Open the S Corp Tax Calculator →
What About a C Corporation?
The C Corp is the “traditional” corporate structure, and it works fundamentally differently from pass-through entities.
Double Taxation
A C Corp pays tax at the entity level at a flat 21% federal rate. When the corporation distributes after-tax profits to shareholders as dividends, those dividends are taxed again on the shareholder’s personal return. This is “double taxation.”
However, the second layer of tax is often lower than people assume:
- Qualified dividends are taxed at preferential rates: 0%, 15%, or 20%, depending on your income
- The Net Investment Income Tax (NIIT) adds 3.8% on investment income for higher earners (AGI above $200,000 single / $250,000 MFJ)
- The combined effective rate on distributed C Corp income ranges from roughly 21% (if dividends fall in the 0% bracket) to about 39.8% (21% corporate + 23.8% on dividends)
For comparison, the top combined rate for a sole proprietor is roughly 50%+ (37% income tax + 15.3% SE tax, partially offset by deductions). The C Corp’s combined rate can actually be competitive at higher income levels.
No Self-Employment Tax
C Corp shareholders who are also employees pay FICA only on their salary, similar to the S Corp. But unlike the S Corp, there is no K-1 income to worry about. Remaining corporate profits are either retained (taxed at 21%) or distributed as dividends (taxed at qualified dividend rates).
No QBI Deduction
The Section 199A QBI deduction is only available for pass-through income. C Corp income does not qualify. This is a significant disadvantage for C Corps at income levels where the QBI deduction is most valuable.
QSBS Exclusion (Section 1202)
One major advantage of C Corp status: if your company qualifies as a “qualified small business” and you hold the stock for at least five years, you may be able to exclude up to $10 million (or 10x your basis) in capital gains when you sell. This is an enormous benefit for startup founders and is not available for S Corps or other pass-through entities.
To qualify, the corporation must have had gross assets of $50 million or less at the time the stock was issued, and it must be an active C Corp (not an S Corp) conducting a qualified trade or business.
When Does a C Corp Make Sense?
- Startups planning for venture capital or an exit: QSBS alone can be worth millions. Most investors require C Corp status anyway.
- Businesses that retain significant earnings: If you do not need to distribute most of the profit, the 21% corporate rate is lower than personal rates for higher earners.
- Income levels where QBI is phased out: If you are above the QBI thresholds (particularly in a specified service trade), the pass-through advantage shrinks and the C Corp’s flat 21% rate looks more attractive.
- Businesses with multiple shareholders or complex equity structures: C Corp governance is well-established and familiar to investors.
For most small service businesses that distribute the majority of their earnings to the owner, the C Corp’s double taxation makes it less attractive than a pass-through structure with or without an S Corp election. But for the right situation, it is the best structure available.
The Bottom Line
The S Corp election is a tool, not a magic trick. For business owners earning above roughly $100,000 in net business income, it usually saves real money after accounting for compliance costs. Below that threshold, you are often trading simplicity for marginal savings that get eaten by accountants and payroll providers.
Before you make the election:
- Run the actual numbers. Use our free S Corp calculator. Include realistic estimates for your CPA, payroll service, and bookkeeping costs.
- Talk to a CPA who will be honest with you. If your accountant is pushing an S Corp election on $50,000 of business income, ask them to show you the math after including their own fees.
- Consider your state. Some states make the S Corp significantly less attractive.
- Think about your growth trajectory. If you are at $70,000 now but expect to be at $150,000 next year, the setup costs this year could be an investment that pays off.
The best tax structure is the one that saves you the most money after all costs, not just on the FICA line. Do the math. Make a grown-up decision. And do not let anyone scare you into anything.
This article is for general informational purposes only and does not constitute legal or tax advice. Every situation is different. Consult with a qualified tax professional before making any elections or structural changes to your business.
BlackHill Law is a corporate, securities, and tax law practice based in Utah. If you need help with entity formation, tax planning, or business structuring, contact us.