How S-Corp vs LLC Taxation Works in 2026
By default, the IRS classifies a single-member LLC as a disregarded entity (sole proprietorship). In this default classification, 100% of your net business profit is subject to the mandatory 15.3% Self-Employment (SECA) tax (12.4% Social Security up to the wage cap plus 2.9% Medicare).
Default Single-Member LLC
All net business revenue flows directly to Schedule C of your personal Form 1040. You pay 15.3% SECA tax on the first $168,600 of net earnings + income taxes on all profit.
LLC Electing S-Corp (Form 2553)
Your LLC files Form 1120-S. You pay yourself a W-2 Reasonable Salary (subject to 15.3% FICA) and withdraw the remaining profits as K-1 Shareholder Distributions (0% FICA tax).
The S-Corp Tax Shield Formula
Your gross self-employment tax savings are calculated purely on the portion of profits taken as distributions rather than salary:
Net Profit vs S-Corp Realized Savings Benchmark Table
| Net Business Profit | Reasonable W-2 Salary | K-1 Distributions | Gross FICA Savings | Admin Costs | Net Annual Savings |
|---|---|---|---|---|---|
| $60,000 | $45,000 | $15,000 | $2,295 | $2,400 | -$105 (Not Worth It) |
| $80,000 (Break-Even) | $50,000 | $30,000 | $4,590 | $2,400 | +$2,190 / year |
| $120,000 | $65,000 | $55,000 | $8,415 | $2,400 | +$6,015 / year |
| $160,000 | $80,000 | $80,000 | $12,240 | $2,400 | +$9,840 / year |
| $250,000+ | $100,000 | $150,000 | $15,000+ | $2,800 | +$12,200+ / year |
How to Determine & Defend Your IRS "Reasonable Salary"
The IRS actively audits S-Corporations that pay artificially low salaries (such as a $10,000 salary on $150,000 profit) to evade payroll taxes. Under IRS Fact Sheet FS-2008-25, the IRS evaluates reasonable compensation using several key criteria:
- Training, Experience & Duties: What would it cost to hire an unrelated employee with your qualifications in your geographic market?
- Time Devoted to Business: Full-time owners (40 hrs/wk) require higher compensation than passive investors.
- Bureau of Labor Statistics (BLS) Benchmarks: Document median wage percentiles (25th to 75th percentile) for your job code.
- The 60/40 Rule of Thumb: Many CPAs use a baseline of 60% salary and 40% distribution as a defensible starting ratio for standard professional service businesses.
Step-by-Step: How to Make the S-Corp Election
Register your Articles of Organization with your Secretary of State and get an IRS EIN.
Mail or fax Form 2553 signed by all shareholders within 75 days of tax year start.
Run payroll with automated tax withholding (Gusto/QuickBooks) and file Form 1120-S by March 15.