The question is not which structure sounds the most legitimate. The question is how much of your profit you are handing to the IRS because you never made a deliberate choice about how your LLC gets taxed.
Most LLCs are taxed as sole proprietorships by default. That means every dollar of profit runs through Schedule C, gets hit with a 15.3% self-employment tax on top of your income tax rate, and you have no mechanism to reduce that exposure without restructuring how your entity is treated at the federal level. If you are earning $100,000 in net profit, you are paying roughly $15,300 in self-employment tax alone before your income tax even enters the picture. At $200,000, that number becomes difficult to look at directly.
The comparison between a sole proprietorship vs LLC vs S corp is not an academic exercise. It is a cash flow decision that compounds every year you delay it.
The Default Tax Structure Is Costing You Money Right Now
When you form an LLC and do nothing else, the IRS treats it as a disregarded entity if you are the sole owner. That is the technical term. What it means practically is that the IRS sees no distinction between you and your business for tax purposes. Your profit is your income, and all of it is subject to self-employment tax under IRC § 1401, which funds Social Security and Medicare at that combined 15.3% rate on the first $176,100 of net earnings in 2025, and 2.9% on everything above that threshold.
This is not a penalty. It is simply the default. The IRS is not doing anything wrong by taxing you this way. You just have not told them to do otherwise, and they are not going to suggest it.
The frustrating part is that most people who form LLCs through an online service or with minimal legal guidance are never told this. They are told they have liability protection, which is true. They are told their business is now separate from them personally, which is partially true. What they are not told is that the tax treatment of their LLC is an entirely separate question from the liability question, and that the default answer to the tax question is almost never optimal once the business starts generating real money.
The liability shield of an LLC and the tax treatment of an LLC are two different things. You can have the liability protection of an LLC while electing to be taxed as an S corporation. These are not mutually exclusive. The confusion between them is one of the most expensive misconceptions in small business ownership.
If you are reading this and you formed your LLC two or three years ago and have been filing a Schedule C ever since, there is a reasonable chance you have overpaid in self-employment taxes by tens of thousands of dollars in aggregate. That is not a hypothetical. That is arithmetic.
What Changes When You Elect S Corp Status (And What Doesn't)
An S corp is not a separate legal entity you form. It is a federal tax election you make on top of an existing entity, whether that entity is a corporation or an LLC. You file IRS Form 2553, you meet the eligibility requirements, and the IRS begins treating your business as an S corporation for tax purposes. The LLC itself, as a state-law entity, does not change.
What changes is how your profit flows. Under S corp taxation, you split your income into two buckets. The first is a reasonable salary that you pay yourself as a W-2 employee of your own company. That salary is subject to payroll taxes, which are the employer and employee equivalent of that same 15.3% self-employment tax. The second bucket is distributions, which represent the remaining profit after your salary. Distributions are not subject to self-employment or payroll taxes. That is the entire mechanism. That is where the savings come from.
If your LLC nets $200,000 and you elect S corp status and pay yourself a reasonable salary of $80,000, you are paying payroll taxes on $80,000 instead of $200,000. The difference in tax exposure on that remaining $120,000 is real money. At the 15.3% rate, you are looking at roughly $18,360 in tax savings on that spread, before accounting for the employer portion of payroll taxes you would also owe on the salary.
The eligibility requirements matter and they are non-negotiable. To elect S corp status, your LLC can have no more than 100 shareholders, all of whom must be U.S. citizens or permanent residents. You cannot have another corporation, LLC, or partnership as an owner. You are limited to one class of stock, or in the LLC context, one class of membership interest. If you have a foreign investor, a corporate co-founder, or a complex ownership structure, the S corp election may not be available to you without restructuring first.
The election also has a timing requirement. Under IRC § 1362(b), the election must generally be filed no later than two months and fifteen days after the beginning of the tax year for which you want it to be effective. Miss that window and you are waiting until the following year. There is a late election relief procedure under Rev. Proc. 2013-30, but it requires showing reasonable cause, and it is not guaranteed.
The LLC Sole Proprietorship vs S Corp Decision Comes Down to One Number
The number is your net profit, and the threshold that most tax professionals use is somewhere between $40,000 and $60,000 in annual net profit. Below that threshold, the administrative cost of maintaining an S corp election typically exceeds the tax savings. Above it, the math starts to move in the other direction, and it moves faster than most people expect.
At $50,000 in net profit, the self-employment tax exposure under default LLC taxation is approximately $7,650. With an S corp election and a reasonable salary of, say, $35,000, you are paying payroll taxes on $35,000 and taking the remaining $15,000 as a distribution. The savings are modest, and when you factor in the cost of payroll processing and additional compliance filings, you may be roughly at breakeven. This is why the $40,000 to $60,000 range is the inflection point, not a hard rule.
At $150,000 in net profit, the calculus is different. The self-employment tax exposure on the full amount is significant, and the ability to characterize a meaningful portion of that income as distributions rather than salary creates real, recurring savings. The compliance costs of the S corp election, which include payroll administration, a separate business tax return on Form 1120-S, and potentially higher accounting fees, are fixed costs that become proportionally smaller as profit grows.
The sole proprietorship vs LLC vs S corp comparison is ultimately a question of where you are right now and where you expect to be in the next two to three years. If you are at $80,000 in net profit today and growing, electing S corp status now makes more sense than waiting until you are at $200,000 and calculating how much you overpaid in the intervening years.
What the comparison is not is a reason to elect S corp status without understanding the reasonable compensation requirement. The IRS is not unaware of the salary-plus-distributions structure. Under IRC § 3121, the IRS requires that S corp owner-employees pay themselves a salary that is reasonable and comparable to what the market would pay someone in the same role. If you net $300,000 and pay yourself a salary of $20,000, you are inviting an audit and the reclassification of your distributions as wages, along with back payroll taxes and penalties. The salary has to be defensible.
Why the S Corp Election Is Not a Set-It-and-Forget-It Move
The election itself takes minutes to file. The ongoing compliance is where people underestimate the commitment. Once you are an S corp for tax purposes, you are running payroll. That means federal and state payroll tax deposits, quarterly filings, W-2s at year-end, and a separate corporate tax return every year. If you are in California, you are also paying the 1.5% franchise tax on S corp net income on top of the $800 annual minimum. Nobody mentions that when they are selling you the S corp election.
The payroll requirement is not optional and it is not something you can handle informally. You need a payroll system, or a payroll service, or an accountant who handles it for you. The cost of that infrastructure at the lower end of the profit range is why the $40,000 to $60,000 threshold exists. Below it, you may be paying $3,500 or more in compliance costs to save $2,000 in self-employment tax. That is not a strategy. That is an expense.
The other ongoing obligation is documentation. The S corp election requires that you treat your business like a business: separate bank accounts, documented distributions, records of how you determined your reasonable salary, and minutes or resolutions if your operating agreement requires them. The same corporate formalities that protect your LLC's liability shield also protect the integrity of your S corp election. If you are not maintaining them, you are exposed on both fronts simultaneously.
There is also the question of what happens when your circumstances change. If you bring on a co-founder who is a foreign national, your S corp election terminates automatically under IRC § 1362(d). If you want to bring in a corporate investor, same result. The S corp structure trades flexibility for tax efficiency, and that trade-off is worth understanding before you make it, not after you have built a cap table that disqualifies you.
The llc vs sole proprietorship vs s corp question is not a one-time decision. It is a structure you maintain, defend, and revisit as your business grows. Getting the election right is step one. Keeping it defensible is the work that follows.
S corp elections, reasonable compensation determinations, and California-specific franchise tax exposure are exactly what Delina's intake sessions are built for.
If you're ready to make a deliberate decision about your LLC's tax structure instead of living with the default, book a paid intake with Delina. This is not a free call. It is a focused, strategic session with an attorney who has read everything above and has specific opinions about your situation.
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