The S-Corp question, explained without the jargon
At some point, every freelancer making decent money hears the same advice: "You should look into an S-Corp." Your accountant says it. Your freelancer friends say it. Someone in a Facebook group says it. Nobody explains what it actually means.
Here's the short version: an S-Corp election lets you split your business income into two buckets — a "salary" and "distributions." You pay self-employment tax (15.3%) on the salary part only. The distribution part is exempt. If your income is high enough, this can save you thousands of dollars per year in taxes.
If your income is nothigh enough, it saves you basically nothing and costs you money in extra paperwork. So the question isn't "should I be an S-Corp" — it's "do I make enough for the tax savings to outweigh the hassle?"
How it actually works
Let's say you net $120,000 as a sole proprietor. Right now, you pay self-employment tax on all of it (well, 92.35% of it, but still). That's about $16,990 in SE tax alone.
With an S-Corp, you'd pay yourself a "reasonable salary" — let's say $72,000 (60% of your net). You pay FICA taxes (same 15.3% rate, split between employer/employee) on that $72,000 only. The remaining $48,000 comes out as a distribution, and you don't pay FICA on it.
SE tax on $120K: ~$16,990. FICA on $72K: ~$11,016. That's roughly $5,974 in savings. Per year. Every year. Not nothing.
The "reasonable salary" trap
You can't pay yourself $1 in salary and take $119,999 as a distribution. The IRS requires a "reasonable salary" — what someone doing your job would actually get paid. If you're a web developer making $120K, paying yourself a $30K salary is going to raise flags.
A common rule of thumb is 50-60% of net income as salary, but it really depends on your industry and what comparable employees earn. If the IRS decides your salary wasn't reasonable, they can reclassify your distributions as wages and charge you back taxes plus penalties. They're not known for their sense of humor about this.
The costs nobody mentions
S-Corp status isn't free. You're adding complexity to your life:
- Payroll — you need to run actual payroll for yourself. That means payroll software ($30-50/month) or a payroll service.
- Extra tax return — S-Corps file Form 1120-S, which is a separate corporate return. Your accountant will charge more for this ($500-$1,500+ extra per year).
- State fees — some states charge franchise taxes or annual fees for S-Corps. California charges a minimum $800/year just for existing.
- More bookkeeping — you need to keep corporate minutes, maintain separate books, and generally act like a real company.
Add it all up and the overhead is roughly $1,500-$3,000 per year. So your tax savings need to clear that bar before you're actually saving money.
The breakeven point
Most accountants say S-Corp election starts making sense when your net self-employment income is around $50,000-$60,000 per year. Below that, the tax savings are too small to justify the extra cost and complexity. Above that, the savings grow with your income and it becomes a pretty clear win.
The calculator above shows you the exact numbers for your situation. If the savings line says "less than $2,000," it's probably not worth the headache. If it says "$5,000+," call your accountant tomorrow.
Frequently asked questions
Is an S-Corp the same as an LLC?
No. An LLC is a legal structure (how your business is organized). S-Corp is a tax election (how your business is taxed). You can have an LLC that's taxed as an S-Corp — and that's actually the most common setup. You keep the liability protection of an LLC while getting the tax benefits of S-Corp status. You file Form 2553 with the IRS to make the election.
Can I switch back if I don't like it?
You can revoke S-Corp status, but the IRS makes you wait 5 years before you can re-elect. So don't flip-flop. Make sure the math works before you commit.
When should I make the election?
You need to file Form 2553 by March 15 of the tax year you want it to take effect (or within 75 days of forming your LLC). If you miss the deadline, you can request late election relief, but it's not guaranteed. Tax deadlines: famously unforgiving.