Default LLC vs LLC electing S-corp, side by side
| Dimension | LLC, taxed by default | LLC electing S-corp |
|---|---|---|
| What it is | A state-law company; pass-through by default | The same company, with a federal S election on Form 2553 |
| How profit is taxed | Passes to owners yearly; earnings generally hit with 15.3% self-employment tax | Passes through yearly; only the salary takes the 15.3% |
| Owner pay | Draws as needed; no payroll required | Reasonable W-2 salary required; the rest as distributions |
| Paperwork | Minimal — the return you already file | Payroll filings, a separate 1120-S return, real bookkeeping |
| Who it fits | Startups, loss years, simplicity, real estate | Profitable service businesses past the payroll break-even |
| The trap | Self-employment tax on every profitable dollar | A salary set too low gets recharacterized — with penalties |
The election, not the entity
This is the sentence that saves people thousands: you do not convert your LLC into an S-corp — you elect S treatment for it. File Form 2553, meet the eligibility rules (100 or fewer shareholders, one class of stock, qualifying U.S. owners), and the same state-law company is taxed under Subchapter S from the effective date. The legal shell, the bank accounts, the contracts — all unchanged. Only the tax math moves.
Reasonable salary is the whole game
The S-corp saves the 15.3% self-employment tax on profit above your salary — which is exactly why the IRS polices the salary. There is no statutory formula; the test is what you would pay a stranger to do your job, weighing duties, hours, and comparable pay. Owners who pay themselves $0 (or a token amount) and distribute the rest invite recharacterization: the IRS treats distributions as wages and bills the payroll tax plus penalties and interest. The election is only as good as the salary defending it.
When the plain LLC wins
Three cases stay put. Low profit: payroll taxes, a separate 1120-S preparation fee, and administration can eat the entire savings — run the break-even before electing. Loss years: default treatment puts losses on your personal return where you may need them. Appreciating property: S-corps and appreciated assets mix poorly, because getting the property out can trigger gain the plain LLC would not. An election should follow the math, not the meme.
Frequently Asked Questions
- Yes, by election — file Form 2553 if the company meets the eligibility rules (100 or fewer shareholders, one class of stock, qualifying owners). Same company, different tax math; the state LLC shell does not change.
- What you would pay someone else to do your job — weighing actual duties, hours, and comparable pay. Set it indefensibly low and the IRS recharacterizes distributions as wages, with penalties and interest on the payroll tax that should have been paid.
- When profit is low enough that payroll taxes, preparation fees, and administration eat the savings; when you need losses on your personal return; or when the business holds appreciating property, which mixes poorly with S treatment.
- No — liability protection comes from the state entity (the LLC or corporation), not the tax election. An S election changes how profit is taxed; it adds no legal shield the entity did not already provide.