Why the S-Corp Election Saves You Money
As a standard single-member LLC, the IRS treats your business as a disregarded entity. This means 100% of your business net profit flows directly onto your personal tax return (Schedule C). Crucially, you must pay 15.3% in Self-Employment (SE) taxes (Medicare and Social Security) on practically all of that profit.
The S-Corp Loophole
When you elect to be taxed as an S-Corporation, you split your income into two distinct categories:
- A Reasonable W-2 Salary: You must place yourself on payroll and pay yourself a fair market wage for the work you do. You pay the 15.3% payroll tax on this portion.
- Owner's Distributions (Dividends): The remaining profit in the business can be taken out as a distribution. This portion is completely exempt from the 15.3% SE tax.
What is a "Reasonable Salary"?
The IRS aggressively audits S-Corps that pay artificially low salaries (or no salaries at all) just to avoid payroll taxes. Your salary must be "reasonable," which the IRS typically defines as what you would have to pay someone else to do your exact job. Factors include your experience, duties, location, and the success of the business.
When Should You Switch?
Most CPAs recommend considering an S-Corp election once your net business income consistently exceeds $60,000 to $80,000 per year. Below this threshold, the costs of running payroll, filing a separate corporate tax return (Form 1120-S), and paying corporate state fees often wipe out any SE tax savings.