An S-Corp (S-Corporation) is not a separate legal business entity, but a special IRS tax election under Subchapter S of the Internal Revenue Code. It allows an LLC or C-Corporation to be treated as a pass-through entity, enabling owners to split net profit between a W-2 reasonable salary and shareholder distributions, avoiding 15.3% self-employment tax on distributions.

How does an S-Corp save money on taxes compared to an LLC?

A standard single-member LLC pays 15.3% self-employment tax (Social Security and Medicare) on 100% of net profits. Under an S-Corp election, only your W-2 reasonable salary is subject to 15.3% FICA; the remaining profit is distributed as dividend/shareholder distributions, which are exempt from self-employment taxes.

What is the income tipping point where an S-Corp election makes sense?

The tipping point is typically around $80,000 to $100,000 in net annual profit. Below $80,000, the extra costs of running payroll software ($600-$900/yr), filing an additional corporate tax return (Form 1120-S costing $800-$1,500), and state S-corp franchise taxes often negate the tax savings.

Does California charge an extra tax on S-Corporations?

Yes. California imposes an additional 1.5% tax on S-Corporation net income (with an $800 annual minimum). If your LLC elects S-Corp status in California, you must factor in this 1.5% state franchise excise tax.

IRS Subchapter S Tax Classification • 2026 Compliance Standards

What is an S-Corp? (LLC vs S-Corporation Explained)

An S-Corp (S-Corporation) is not a separate legal business entity, but a special IRS tax status (Form 2553 election) that allows an LLC or corporation to pass net income directly to owners’ personal tax returns, shielding shareholder profit distributions from the 15.3% self-employment tax (FICA).

1. Pass-Through Taxation

Profits and losses flow directly to shareholders' personal Form 1040. Avoids federal corporate double taxation.

2. 15.3% FICA Savings

Self-employment tax (Social Security & Medicare) is paid only on W-2 salary. Remaining profits are distributed tax-free from FICA.

3. Limited Liability Preserved

Your underlying state-registered LLC remains unchanged. Your personal assets remain fully protected under state corporate law.

Comparison between Standard LLC and S-Corporation Tax Status
Comparison Factor	Standard LLC (Default)	LLC with S-Corp Election (Form 2553)
Legal Business Structure	State-registered LLC	State-registered LLC (identical legal shield)
IRS Tax Classification	Disregarded Entity (Schedule C) / Partnership	S-Corporation (Form 1120-S Corporate Return)
15.3% Self-Employment Tax	Paid on 100% of Net Profits	Paid ONLY on W-2 Reasonable Salary
Shareholder Distributions	All subject to 15.3% FICA	0% FICA Self-Employment Tax
Annual Overhead Costs	$0 extra (standard tax filing)	~$1,500–$2,500/yr (Payroll software + CPA 1120-S)
Recommended Profit Threshold	Under $80,000/yr net income	Over $80,000–$100,000/yr net income

2026 Self-Employment Tax Savings Calculator

Should Your LLC Elect S-Corp Tax Status?

By paying yourself a W-2 salary and taking the rest of your business profit as shareholder distributions, you avoid the 15.3% self-employment tax on distributions.

Select Your State of Operation:State franchise tax and S-corp entity fees are calculated automatically.

Annual Net Business Profit:$120,000

$40,000$200,000$400,000+

Reasonable W-2 Salary Allocation:IRS requires a defensible "reasonable salary" for the services you provide (typically 40%–50%).

45% ($54,000/yr)

Option A

Standard LLC

Default Pass-Through

Self-Employment Taxable Base:$120,000

FICA / SE Tax Rate:15.3%

Total SE Taxes Paid:$16,955

Payroll Compliance Cost:$0

Corporate Tax Prep:$0 (Schedule C)

Option B

S-Corp Tax Election

Form 2553 Election

W-2 Salary (FICA applies):$54,000

Distributions (FICA EXEMPT):$66,000

Total FICA Taxes Paid:$8,262

Payroll Software (Gusto):-$650

Form 1120-S CPA Prep:-$1000

California S-Corp Tax:-$1,800

Final Recommendation

Save $5,243/year

At $120,000 profit in California, your self-employment tax savings ($8,693) easily outweigh the additional payroll and accounting costs ($3,450).

Gross FICA Tax Saved:+$8,69315.3% tax shielded on $66,000 of distributions

IRS Compliance Standards

How the IRS "Reasonable Salary" Rule Works

Many founders mistakenly believe they can pay themselves a $10,000 salary and take $190,000 in tax-free distributions. Under IRS guidance (Revenue Ruling 74-44), shareholder-employees must be paid fair market value compensation for the services they provide.

If the IRS audits your S-Corporation and determines your salary was artificially low, they can reclassify all distributions as wages, assess back FICA taxes, and levy stiff penalties.

General Rule of Thumb:For most single-owner knowledge workers (software engineers, consultants, therapists, designers), CPA firms generally recommend a salary-to-distribution split between 40%/60% and 50%/50% based on industry BLS wage data.