Compare sole proprietorship vs S-corporation to estimate annual tax savings from reduced self-employment taxes
🔹 This calculator compares two scenarios: operating as a sole proprietor (or single-member LLC taxed as a disregarded entity) versus electing S-corporation tax status. The fundamental difference lies in how employment taxes are calculated.
🔹 As a sole proprietor, you pay self-employment tax (15.3%) on 92.35% of your entire net business profit. This covers both the employer and employee portions of Social Security (12.4%) and Medicare (2.9%) taxes.
🔹 As an S-corporation, you become an employee of your own company. You pay yourself a "reasonable salary" which is subject to FICA taxes (same 15.3%, split between employer and employee). However, any profit beyond your salary is distributed as a K-1 distribution, which is NOT subject to self-employment tax.
🔹 Sole Proprietor: Net Profit × 92.35% × 15.3% = Self-Employment Tax. Half of this SE tax is deductible from AGI, and the remaining profit (minus half SE) qualifies for the 20% QBI deduction.
🔹 S-Corporation: Salary × 15.3% = Total FICA (split employer/employee). The employer portion is a business expense. Remaining profit (Net - Salary - Employer FICA) passes through as K-1 distribution with no SE tax, but IS subject to QBI deduction.
🔹 The savings come from avoiding the 15.3% self-employment tax on the K-1 distribution portion. At $150,000 profit with 50% salary ($75,000), you save SE tax on the $75,000 distribution - approximately $11,000.
💡 Pro Tip: The savings aren't entirely "free" - you lose the half-SE deduction, and your QBI deduction base changes. This calculator accounts for all these factors to show true net savings.
🔹 Use this calculator when you're considering whether to elect S-corporation tax status for your LLC or corporation. The decision typically makes sense when your net business profit consistently exceeds $60,000-$80,000 annually.
🔹 S-Corp election (Form 2553) must be filed within 75 days of the start of the tax year, or anytime during the preceding year. Late elections may be accepted with reasonable cause.
🔹 If you're mid-year and want S-Corp treatment, you can file for next year. Some practitioners file late elections claiming reasonable cause, but acceptance isn't guaranteed.
🔹 Run multiple scenarios: vary your salary percentage from 40% to 60% to see the sensitivity. Consider both best-case and worst-case income projections.
💡 Pro Tip: If savings are borderline ($2,000-$5,000), consider whether the administrative hassle is worth it. Some business owners value simplicity over modest tax savings.
🔹 The IRS requires S-Corp owner-employees to receive "reasonable compensation" for services rendered. This is the most scrutinized aspect of S-Corp tax planning.
🔹 Factors the IRS considers:
🔹 Sole Proprietor/Disregarded LLC: All profit flows to your personal return on Schedule C. You pay SE tax on it all. Simple, but expensive at higher income levels.
🔹 S-Corporation: Files its own return (Form 1120-S). Profit passes through on Schedule K-1. You're an employee receiving W-2 wages. More complex, but can save significant taxes.
🔹 Self-employment tax = 15.3% on 92.35% of net SE income:
🔹 The 92.35% factor exists because employers can deduct their share of FICA - you get the same benefit applied to your SE tax calculation.
🔹 The Qualified Business Income deduction allows a 20% deduction on qualified business income. Key differences between sole prop and S-Corp:
🔹 SSTB Warning: Specified Service Trades or Businesses (law, accounting, health, consulting, financial services) face income-based phase-outs. Above certain thresholds, the QBI deduction phases out entirely.
🔹 S-Corps require:
🔹 The biggest mistake S-Corp owners make is setting unreasonably low salaries to maximize tax savings. The IRS actively audits this.
🔹 Red flags for auditors:
💡 Safe harbor: Most tax professionals suggest 40-60% of net profit as salary for service businesses where the owner is the primary revenue generator.
🔹 Many calculators (and business owners) underestimate S-Corp administrative costs:
🔹 Total realistic cost: $1,500-4,000 annually. This calculator lets you input your actual expected costs.
🔹 Don't elect S-Corp status just because you heard it "saves taxes." At lower income levels (under $60K profit), the costs and hassle outweigh the benefits.
🔹 Wait until you have: consistent profitability, predictable income, and enough savings to absorb the administrative overhead.
🔹 S-Corp election (Form 2553) must be filed:
🔹 Missing this deadline means waiting another year or requesting late election relief (not guaranteed).
🔹 S-Corps require more formality than sole proprietorships. Never:
🔹 The key to S-Corp tax savings is finding the optimal salary percentage. Use this calculator to test different percentages:
💡 Pro Tip: Document your salary rationale. Keep records of comparable salaries, industry surveys, and time tracking.
🔹 S-Corp owners can contribute to employer-sponsored retirement plans:
🔹 Key difference: Employer contributions are based on your W-2 SALARY, not total profit. Higher salary = higher retirement contribution limits.
🔹 If your income is growing, consider timing:
🔹 S-Corp election works well with:
🔹 S-Corps have different implications for business sale:
🔹 If you're planning to sell within 5 years, discuss with a tax professional whether S-Corp status helps or hurts your exit strategy.
🧮 I've built several other tax planning tools to complement this S-Corp analysis:
🔹 California imposes an additional 1.5% S-Corp tax on net income (minimum $800 franchise tax). This is factored into your overall tax planning but not shown separately in this calculator.
🔹 While this calculator provides accurate estimates, S-Corp election involves complex considerations. I recommend consulting:
💡 I offer consultations on entity selection, S-Corp compliance, and business tax planning for California clients.
❓ Comprehensive answers to common questions about S-Corp election, tax savings, and compliance.
An S-Corp election allows an LLC or corporation to be taxed under Subchapter S of the Internal Revenue Code. It doesn't change your legal entity - an LLC electing S-Corp status is still legally an LLC. The election changes only how the IRS taxes your business income. By filing Form 2553 with the IRS, you elect to have business profits pass through to your personal return while allowing you to split income between salary (subject to employment taxes) and distributions (not subject to employment taxes).
An LLC is a legal entity type that provides liability protection. S-Corp is a tax election that determines how income is taxed. You can have an LLC taxed as a sole proprietor (default for single-member), partnership (default for multi-member), C-Corp, or S-Corp. Many business owners form an LLC for liability protection, then elect S-Corp tax treatment once income justifies the additional compliance. The legal protections remain the same - only the tax treatment changes.
No. S-Corps have eligibility requirements: (1) must be a domestic entity, (2) maximum 100 shareholders, (3) only one class of stock, (4) shareholders must be individuals, estates, or certain trusts - no corporations or partnerships, (5) no nonresident alien shareholders. Most small business owners easily qualify, but these rules matter if you're planning to raise investment capital or have complex ownership structures. C-Corps don't have these restrictions.
Most tax professionals recommend S-Corp election when net business profit consistently exceeds $60,000-$80,000 annually. Below this threshold, administrative costs (payroll, tax prep, bookkeeping) typically exceed the tax savings. The election must be filed using Form 2553 within 75 days of the start of the tax year, or anytime during the preceding year. Plan ahead - you can't retroactively elect for the current year after the 75-day window closes.
Savings depend on your net profit and salary percentage. At $150,000 net profit with 50% salary ($75,000), you save approximately 15.3% SE tax on the $75,000 distribution portion - about $11,475. However, you lose the half-SE deduction (worth about $2,700 in tax savings at 24% bracket) and face S-Corp admin costs ($1,500-4,000). Net savings: approximately $6,000-9,000 annually. Use this calculator with your actual numbers for precise estimates.
The savings come from avoiding self-employment tax on distributions. As a sole proprietor, ALL profit is subject to 15.3% SE tax. As an S-Corp, only your salary is subject to FICA. The distribution portion (profit minus salary minus employer FICA) avoids employment taxes entirely. At higher income levels, you also avoid the 0.9% Additional Medicare Tax on distributions since it only applies to wages.
The S-Corp election primarily affects employment taxes (SE tax vs FICA), not income tax. However, there are secondary income tax effects: (1) you lose the half-SE tax deduction available to sole proprietors, (2) your QBI deduction base changes since salary is not QBI, only the K-1 distribution, (3) employer FICA becomes a deductible business expense. This calculator accounts for all these factors.
The Qualified Business Income (QBI) deduction (Section 199A) allows a 20% deduction on qualified business income. For sole proprietors, QBI = net profit minus half of SE tax. For S-Corps, QBI = only the K-1 distribution (salary is W-2 income, not QBI). At higher income levels ($197,300 single / $394,600 MFJ for 2025), QBI faces additional limitations based on W-2 wages paid - which benefits S-Corps that pay substantial salaries.
Reasonable compensation is the salary an S-Corp owner-employee must receive for services rendered. The IRS requires this to prevent owners from avoiding employment taxes by taking all income as distributions. Factors considered include: duties performed, time devoted, training and experience, comparable salaries in similar businesses, dividend history, and compensation of non-shareholder employees. There's no fixed formula - it's based on facts and circumstances.
For service businesses where the owner is the primary revenue generator, 40-60% of net profit as salary is generally considered reasonable. Some factors that might justify lower percentages: significant capital investment in the business, substantial passive income sources, multiple employees contributing to revenue. Factors requiring higher percentages: owner performs all services, no other employees, highly skilled professional services. Document your rationale.
The IRS can reclassify distributions as wages, assessing back FICA taxes plus penalties and interest. In severe cases, the IRS might revoke S-Corp status entirely. Warning signs that trigger audits: $0 salary with significant profit, salary far below industry norms, inconsistent salary year-to-year without business justification. The IRS has won numerous court cases against taxpayers with unreasonably low salaries.
Research comparable salaries using: Bureau of Labor Statistics data, industry salary surveys, job postings for similar roles, salary websites like Glassdoor or PayScale, professional association surveys. Document your research. Consider hiring a compensation consultant or CPA to prepare a reasonable compensation analysis, especially if your salary is on the lower end or you're in a highly-scrutinized profession.
S-Corps require: (1) payroll processing with W-2s and quarterly payroll tax filings (Forms 941), (2) annual Form 1120-S corporate return, (3) Schedule K-1 to each shareholder, (4) state annual reports and franchise taxes, (5) maintaining corporate formalities (separate bank account, documented distributions). Many owners use payroll services ($50-150/month) and hire CPAs ($500-1,500 additional) for the corporate return.
File IRS Form 2553 (Election by a Small Business Corporation). The form requires: EIN, entity information, shareholder consent signatures, and election effective date. File within 75 days of the start of the tax year you want S-Corp treatment, OR anytime during the preceding year. File by mail or fax to the appropriate IRS service center. Keep a copy of the signed form and proof of filing.
Yes, if you file Form 2553 within 75 days of formation (for new entities) or within 75 days of the start of the tax year. If you miss the deadline, you can request late election relief by checking the appropriate box on Form 2553 and providing reasonable cause. Alternatively, you can file now for the election to be effective January 1 of the following year. The IRS has been relatively lenient with late election relief.
California requires: (1) Form 100S annual S-Corp return, (2) 1.5% tax on net income (minimum $800 franchise tax), (3) LLC fee if applicable (based on gross receipts), (4) Statement of Information filed biennially with Secretary of State, (5) quarterly payroll tax filings with EDD. California doesn't automatically recognize federal S-Corp election - you must separately elect with the Franchise Tax Board or file Form 100S.
You don't "convert" - an LLC can simply elect S-Corp tax treatment while remaining legally an LLC. The decision depends on: consistent profit above $60K, ability to pay yourself reasonable W-2 salary, willingness to handle payroll and additional tax filings, and long-term business plans. If you're planning to raise venture capital, note that S-Corps can't have corporate shareholders or multiple stock classes - you'd need to revoke the election.
Yes. S-Corp election can be revoked by shareholders owning more than 50% of shares filing a revocation statement with the IRS. The revocation can be prospective (effective future date) or retroactive to January 1 if filed by March 15. Once revoked, you generally can't re-elect S-Corp status for 5 years without IRS consent. Consider revocation if you need to raise equity investment or if your situation changes significantly.
As an S-Corp owner-employee, you can contribute to employer-sponsored plans: Solo 401(k) allows $23,500 employee contribution (2025) plus employer contribution up to 25% of W-2 salary. SEP-IRA allows up to 25% of W-2 salary. Key difference from sole proprietorship: contributions are based on your W-2 SALARY, not total profit. Higher salary = higher retirement contribution limits. Plan your salary accordingly if maximizing retirement savings is important.
For most small businesses, S-Corp is better due to pass-through taxation (no double taxation). C-Corps pay corporate tax (21%) plus shareholders pay tax on dividends (potential double taxation). However, C-Corps might be better if: you're planning significant VC investment, need multiple stock classes, have foreign shareholders, or plan to retain substantial earnings for growth. The 2017 tax law's 21% C-Corp rate makes this analysis more nuanced than before.
Need personalized guidance on S-Corp election, reasonable compensation analysis, or business entity planning? I offer consultations for California clients on tax planning and business law matters.