An S-Corp is not a different kind of company. It is a tax election your LLC can make with the IRS. The goal is simple: pay less self-employment tax. Here is how it works and when it makes sense.
The problem: self-employment tax
As a regular single-member LLC, all of your profit is subject to self-employment tax of about 15.3% (Social Security and Medicare), on top of income tax. On $80,000 of profit, that is roughly $11,300 in self-employment tax alone.
How an S-Corp changes it
With an S-Corp, you pay yourself a reasonable salary through payroll. Payroll taxes apply to that salary. The rest of the profit comes out as a distribution, which is not subject to the 15.3%. Using the same example, with a $40,000 salary, payroll taxes would be about $6,100, a possible saving of around $5,000 per year before extra costs.
What it costs to run an S-Corp
- Payroll every month or quarter, with payroll tax filings
- A separate business tax return (Form 1120-S) every year
- Better bookkeeping, because the IRS expects clean records
- In Nevada, wages can also affect the Modified Business Tax
These costs usually add up to a few thousand dollars a year, so the savings must be bigger than that.
When it usually makes sense
As a rule of thumb, an S-Corp starts to make sense when your business profit is consistently around $40,000 to $50,000 or more per year, after expenses. Below that, the extra cost often eats the savings.
The "reasonable salary" rule
You cannot pay yourself $10,000 and take the rest as distributions. The IRS expects a salary similar to what you would pay someone else for your work. A salary that is too low is one of the most common audit issues for S-Corps.
How and when to elect
The election is made with Form 2553. For it to apply to the current year, it is generally due within two months and 15 days after the start of the tax year, which is around March 15 for most businesses. Late elections are sometimes accepted with relief.