LLC vs. S-Corp: Which Business Structure Saves You More Tax

7 min read

Tax Planning

The moment a side hustle becomes real income, the question arrives: should I form an LLC, elect S-corp status, or stay a sole proprietor? The answer is mostly a tax math problem — with a few legal and administrative layers on top.

The Three Structures

Sole proprietorship: No entity at all. Your business income flows directly onto your personal tax return (Schedule C). You pay income tax plus the full 15.3% self-employment tax on your net profit. Zero setup, zero paperwork, but no liability separation.
LLC (single-member): A legal entity that separates business liability from your personal assets. By default, a single-member LLC is taxed exactly like a sole proprietorship — the LLC changes your legal protection, not your tax bill. An LLC doesn't change how you're taxed until you make an election.
S-corp: A tax election (available to LLCs and corporations) that changes how your income is taxed. Instead of all profits being subject to self-employment tax, you pay yourself a reasonable salary (subject to payroll taxes) and take the remaining profit as a distribution — which is subject to income tax but not self-employment tax.

The Tax Math That Drives the Decision

Self-employment tax (15.3%) applies to every dollar of sole-proprietor profit up to the Social Security wage base. An S-corp only pays that 15.3% on your salary, not on distributions.

The example: Suppose your business nets $120,000. As a sole proprietor, roughly 15.3% of that (minus the half-you-can-deduct adjustment) is self-employment tax — call it $15,000+. As an S-corp, you might set a reasonable salary of $70,000 (payroll taxes on that) and take $50,000 as a distribution (no SE tax). The savings can be $5,000–$7,000 a year.

The catch: that savings has to cover the costs — payroll processing, a separate S-corp tax return, and often a CPA. Plus, the IRS requires your salary to be "reasonable." Underpay yourself to dodge taxes, and the IRS can recharacterize your distributions as wages.

The QBI Deduction Applies Either Way

Whichever structure you choose, the 20% Qualified Business Income deduction (Section 199A) generally applies to your business income. It's now permanent law, and it's one of the biggest reasons running a business beats a job on taxes. The main exception: "specified service" businesses (doctors, lawyers, consultants) phase out the deduction above certain income thresholds.

When the S-Corp Election Pays Off

The common guidance: consider the S-corp election when your business nets roughly $80,000–$100,000+. Below that, the administrative burden usually isn't worth the savings. Above it, the math gets increasingly favorable — up to a point, because Social Security taxes eventually cap out anyway.

The S-corp also has a retirement superpower: you can contribute to a Solo 401(k) as the employee (salary deferral) and as the employer (profit-sharing), which stacks nicely with the distribution strategy.

The Legal Layer

The LLC exists for a reason that has nothing to do with taxes: liability protection. If your business could face lawsuits or debts, a properly maintained LLC separates your business liabilities from your house and savings. A sole proprietorship offers no such shield. If you're doing risky work, form the LLC regardless of the tax question — then decide separately whether to make the S-corp election.

The Bottom Line

Start as a sole proprietor (or LLC) while income is small. Form an LLC when you want liability protection. Elect S-corp status when your net income crosses roughly the $80,000–$100,000 mark and the SE-tax savings clearly exceed the administrative costs. It's not a status symbol — it's arithmetic.