One of the most common questions from new business owners: "Should I be an LLC or an S-Corp?" The answer depends on how much you make, what you do, and what your goals are. Here's a practical comparison written for Snohomish County small businesses.
First, Some Vocabulary
The confusion starts because "LLC" and "S-Corp" aren't really comparable categories.
- LLC is a legal entity type (formed at the state level)
- S-Corp is a tax election (filed with the IRS)
An LLC can choose to be taxed as a sole proprietor, a partnership, an S-Corp, or a C-Corp. So the real question is usually: "Should my LLC elect S-Corp tax treatment?"
Default LLC Taxation (No S-Corp Election)
By default, a single-member LLC is taxed as a sole proprietor. A multi-member LLC is taxed as a partnership. In both cases, all profit is reported on the owner's personal return and is subject to:
- Federal income tax (10% to 37%)
- Self-employment tax of 15.3% on ALL profit (12.4% Social Security + 2.9% Medicare)
That self-employment tax is the killer. On $100,000 of profit, you owe $15,300 in SE tax — before any income tax.
How S-Corp Election Saves You Money
When you elect S-Corp tax treatment, your business becomes a "pass-through" entity, but with a critical difference: you must pay yourself a "reasonable salary" subject to payroll taxes, and the rest of the profit comes out as distributions that are NOT subject to self-employment tax.
As LLC (sole prop): 15.3% SE tax on $100K = $15,300
As S-Corp: Pay yourself $50K reasonable salary. Payroll tax on $50K = $7,650 (employer + employee Medicare/SS combined). Distribution of $50K has NO SE tax.
Savings: ~$7,650/year
The Catch: S-Corps Cost More to Run
S-Corps require:
- Separate corporate tax return (Form 1120S) every year — typically $800-$1,500 in CPA fees
- Payroll system (you're now an employee of your own company) — $600-$1,200/year
- Quarterly payroll tax filings (941s)
- Annual W-2 to yourself
- "Reasonable salary" documentation (the IRS audits this)
- Strict separation of business and personal finances
The Break-Even Point
For most small businesses in Snohomish County, S-Corp election starts to make sense at approximately:
- $50,000-$60,000 net profit: Borderline — possible savings, but accounting cost may eat most of it
- $60,000-$80,000 net profit: Usually worth it — net savings of $1,000-$3,000/year
- $80,000+ net profit: Almost always worth it — net savings of $4,000+/year
What Counts as "Reasonable Salary"
The IRS expects S-Corp owners to pay themselves what someone would reasonably earn doing similar work. The lower your salary (and higher your distribution), the more SE tax you save — but the IRS audits this hard.
Rule of thumb: salary should be roughly 30-50% of total compensation, depending on industry and what comparable jobs pay.
Other Reasons to Consider S-Corp
- Health insurance premiums: Deductible above-the-line for S-Corp owner-employees
- Retirement plans: Solo 401(k) and SEP-IRA contributions can be larger as an S-Corp
- Liability separation: Same as LLC, but with more formal corporate structure
When Sole Prop / Default LLC is Still Better
- Profit under $50K — accounting overhead exceeds tax savings
- Side business with low predictability
- You hate paperwork (and no, that's not a joke — S-Corps demand more discipline)
- Real estate investing (different tax treatment usually favors LLC)
When C-Corp Might Make Sense
Most small businesses should NOT be C-Corps because of "double taxation" (corporate tax + dividend tax). C-Corp makes sense when:
- You're seeking outside investment from venture capital
- You expect to retain large amounts of profit in the company for growth
- You want to offer stock options to employees
- You qualify for QSBS (Qualified Small Business Stock) treatment
Making the Switch
To elect S-Corp treatment for an existing LLC, file Form 2553 with the IRS. The election is generally retroactive to the start of the tax year if filed within 75 days. We can handle the form and help you set up payroll if it makes sense for your situation.
The Decision Tree
- Net profit under $50K? Stay LLC.
- Net profit $50K-$80K, willing to do payroll? Maybe S-Corp.
- Net profit over $80K? Almost certainly S-Corp.
- Real estate investor? Stay LLC.
- Need outside investors? Consider C-Corp.
Every situation is different — these are general guidelines, not advice for your specific case. Schedule a consultation and we'll look at your actual numbers.
Should Your Business Be an S-Corp?
Pamela Beaton, CPA can analyze your specific numbers, advise on entity election, file the S-Corp election if it makes sense, and help you set up the payroll and bookkeeping that come with it.
Call 360-435-3440