How an S corp can save tax
As a sole proprietor (or a single-member LLC), all of your profit is subject to self-employment tax: 15.3% on 92.35% of it, up to the Social Security wage base. An S corp splits your profit in two:
- A salary you pay yourself through payroll. Social Security and Medicare (7.65% from you and 7.65% from the company) apply to this part.
- The rest of the profit, which reaches you as a distribution on a K-1. It's taxed as income but has no Social Security or Medicare tax.
The lower the salary, the bigger the saving — which is why the IRS requires it to be reasonable.
What counts as a reasonable salary
The IRS expects an S-corp owner who works in the business to be paid what the business would have to pay someone else to do that work. There's no fixed percentage. Look at what employees in your field and area earn, and keep notes on how you decided. Paying yourself too little is one of the things the IRS looks for, and it can reclassify distributions as wages.
The costs of running an S corp
- Payroll: a payroll service, quarterly payroll returns and W-2s — often a few hundred dollars a year or more.
- A separate tax return: Form 1120-S, usually prepared by an accountant.
- State fees and taxes: many states charge annual fees, and some tax S corps directly — California, for example, charges 1.5% of the S corp's net income, with an $800 minimum.
- More paperwork: a separate bank account, bookkeeping and following formalities.
Enter these under "Extra S-corp costs". The calculator subtracts them from your saving.
Other things to weigh
- Social Security benefits are based on what you pay in, so a lower salary can mean a lower retirement benefit later.
- Retirement savings: solo 401(k) contributions as an S corp are based on your salary, not your whole profit.
- The QBI deduction can shrink: the salary itself doesn't qualify, and at higher incomes the deduction is limited to 50% of the wages the S corp pays.
- Profit level: below roughly $40,000–$50,000 of profit, the costs usually outweigh the savings.
Frequently asked questions
How do I become an S corp?
Form an LLC or a corporation in your state, then file Form 2553 with the IRS to elect S-corp status. There are deadlines for when the election takes effect, so check them with a tax professional before you file.
Does this include state tax?
No. It compares federal taxes only: income tax, self-employment tax and payroll tax. State income tax treats most of the profit the same either way, but state S-corp fees and taxes can change the answer.
Is this tax advice?
No. It's an estimate to help you decide whether to talk to an accountant about it. The right salary and the real costs depend on your situation.