The Core Trade-Off
An LLC taxed as a sole proprietorship (or partnership) pays self-employment tax on all net business income — 15.3% up to the Social Security wage base ($176,100 for 2025), then 2.9% Medicare above that, plus 0.9% Additional Medicare Tax above $200K/$250K.
An S-Corp pays FICA only on the shareholder-employee's W-2 salary. Distributions above that salary are not subject to SE/FICA tax.
The potential savings: if your business earns $200,000 and you pay yourself $80,000 in salary, you save SE tax on $120,000 of distributions. At 15.3%, that's approximately $18,360 in FICA savings.
But it's not that simple. S-Corp election introduces costs and trade-offs that can erode or eliminate that savings.
When S-Corp Election Makes Sense
- Net self-employment income consistently above $40,000-$50,000/year
- Business income is stable and predictable (not highly variable)
- Willing to run payroll and file a separate business return (Form 1120-S)
- In NJ: BAIT election adds additional federal SALT deduction benefit
- Above the QBI threshold: S-Corp W-2 wages unlock the §199A deduction (see QBI guide)
When S-Corp Election Can Hurt
S-Corp isn't always beneficial. The scanner's bracket-level comparison sometimes shows S-Corp increasing total tax burden. This happens when:
- QBI deduction loss exceeds SE tax savings: Paying yourself W-2 wages reduces S-Corp income (and therefore QBI). If you're below the threshold where W-2/UBIA limits don't apply, the lost QBI deduction can outweigh the FICA savings.
- Very low income: Admin costs ($2,000-$3,000/year for payroll, bookkeeping, Form 1120-S) eat into thin margins.
- Highly variable income: You must pay yourself reasonable compensation even in lean years.
- Planning to wind down: Dissolving an S-Corp is more complex than closing a sole proprietorship.
Key insight: A proper comparison must calculate the full entity comparison at the bracket level — federal income tax, SE tax, FICA splits, QBI deduction impact, and admin costs — not just the headline FICA savings number.
Admin Costs of S-Corp
| Item | Typical Annual Cost |
|---|---|
| Payroll service | $500-$1,000 |
| S-Corp tax return (Form 1120-S) | $1,500-$3,000 |
| Quarterly payroll tax filings | Included in payroll service |
| State registration / annual reports | $50-$300 |
| Total estimated | $2,000-$4,000+ |
These costs must be subtracted from any FICA savings to determine true net benefit.
Frequently Asked Questions
At what income should I consider S-Corp election?
The general threshold for considering S-Corp election is when net self-employment income consistently exceeds $40,000-$50,000 per year. Below this level, the administrative costs ($2,000-$4,000/year for payroll and 1120-S filing) often exceed the FICA tax savings.
Can S-Corp election increase my taxes?
Yes. If you're below the QBI threshold ($197,300 single / $394,600 MFJ for 2025), paying yourself W-2 wages as an S-Corp shareholder reduces your QBI and therefore your §199A deduction. If the lost QBI deduction exceeds the FICA tax savings, S-Corp election increases your total tax burden.
What is reasonable compensation for an S-Corp?
The IRS requires S-Corp shareholder-employees to pay themselves 'reasonable compensation' for services rendered (IRC §1366(e), §7436). There's no fixed formula, but factors include: comparable wages for similar work, time devoted, experience, and business revenue. Artificially low salaries risk IRS reclassification of distributions as wages.
How much can I save with S-Corp election?
Savings depend on your income level, but a rough estimate: for every $100,000 of business income above your reasonable salary, you save approximately $15,300 in self-employment tax (15.3%). Net of admin costs ($2,000-$4,000), true savings on $100K of distributions is approximately $11,000-$13,000.