LLC Taxed as S Corp: Pros, Cons & How to File

Choosing between an LLC taxed as an S corporation versus a regular LLC is one of the most common dilemmas we see from business owners looking to save on taxes. Both give you liability protection, but they handle taxes very differently — and that difference can save (or cost) you thousands of dollars per year.

The short answer: If you’re earning under $60,000 net profit annually, stick with a regular LLC. If you’re profitable and earning $80,000+ in net income, an LLC with S corp election will likely save you money on self-employment taxes. If you want maximum flexibility and might raise venture capital later, keep it simple with a regular LLC.

Quick Comparison

LLC with Default Taxation Explained

An LLC (Limited Liability Company) is a business structure that protects your personal assets from business debts and lawsuits. By default, the IRS treats single-member LLCs as “disregarded entities” — meaning the business income and expenses flow directly to your personal tax return on Schedule C.

For multi-member LLCs, the default is partnership taxation. The LLC files an informational return (Form 1065), but the profits and losses still pass through to the owners’ personal tax returns.

How it’s taxed: You pay income tax on all profits, plus self-employment tax (15.3%) on your share of the business income. This self-employment tax covers Social Security and Medicare — it’s like the employer and employee portions of payroll taxes combined, because you’re both.

Real pros:

Simple setup and ongoing compliance
Maximum flexibility in profit sharing and ownership structure
No salary requirements or payroll hassles
Can have foreign owners and unlimited number of owners
Easy to reinvest profits back into the business

Real cons:

Self-employment tax hits your entire net profit (can be $12,000+ annually on $80,000 profit)
Harder to separate business and personal finances in the eyes of lenders
Some employee benefits aren’t tax-deductible for owners

Best for: Freelancers, consultants, small partnerships earning under $60,000 net annually, businesses that want maximum ownership flexibility, or anyone planning to raise venture capital eventually.

LLC Taxed as S Corporation Explained

This is where it gets interesting. You can form an LLC but elect to be taxed like an S corporation by filing Form 2553 with the IRS. You get the liability protection and operational flexibility of an LLC, but the potential tax savings of S corp taxation.

How it’s taxed: The business profits still pass through to your personal tax return (no double taxation), but here’s the key difference — you only pay self-employment tax on the salary you pay yourself. Any remaining profits are distributed to you as “distributions” that aren’t subject to self-employment tax.

The catch? You must pay yourself a “reasonable salary” for the work you do. The IRS requires this salary to reflect what you’d pay someone else to do your job.

Real pros:

Significant self-employment tax savings on profits above your salary
Still get pass-through taxation (no double taxation like C corps)
Retain most of the operational flexibility of an LLC
Some fringe benefits are tax-deductible

Real cons:

Must run payroll and pay yourself a reasonable salary
More paperwork: quarterly payroll taxes, annual S corp return (Form 1120S)
Limited to 100 owners, all must be U.S. persons
Harder to have different classes of ownership or profit-sharing arrangements
Costs more to maintain (payroll service, additional tax prep)

Best for: Profitable businesses with consistent income over $80,000 net annually, service businesses where the owner does substantial work, businesses with steady cash flow to support regular payroll.

The Tax Difference — This Is the Big One

Let’s walk through a real example. Say you’re a marketing consultant with an LLC that nets $100,000 in annual profit after all business expenses.

LLC with default taxation:

Income tax: $100,000 (taxed at your marginal rate)
Self-employment tax: $100,000 × 15.3% = $15,300
Total additional tax burden: $15,300

LLC taxed as S corp:

Reasonable salary (let’s say $60,000 for a marketing consultant)
Payroll taxes on salary: $60,000 × 15.3% = $9,180
Remaining profit distributed: $40,000 (no self-employment tax)
Total additional tax burden: $9,180
Annual savings: $6,120

The S corp election saved you over $6,000 per year in this example. But remember — you’ll have additional costs for payroll processing and tax preparation, typically $1,000-3,000 annually. You’re still ahead by $3,000-5,000.

When the math stops working:

If your net profit is only $50,000 and you need to pay yourself a $45,000 reasonable salary, you’re only saving self-employment tax on $5,000 of income — about $765 per year. After payroll and tax prep costs, you might break even or lose money.

Talk to a CPA when:

Your net business income consistently exceeds $60,000
You’re unsure what constitutes a “reasonable salary” in your industry
You have multiple business income streams
You’re considering this election mid-year (timing matters for tax purposes)

Ownership, Management & Raising Money

Regular LLCs give you maximum flexibility. Want to give your business partner 60% of the profits but only 40% of the voting power? Easy with an LLC operating agreement. Planning to bring in an investor who gets their money back first before other owners see distributions? LLCs can handle complex arrangements like this.

S corp taxation limits your options. All owners must be U.S. citizens or permanent residents. You can’t have different classes of ownership — everyone with the same ownership percentage gets the same distribution percentage.

For raising money: Venture capitalists and angel investors typically prefer C corporations, not LLCs with S corp elections. If you think you’ll raise significant outside capital, stick with a regular LLC (easier to convert to C corp later) or start with a C corp from the beginning.

For selling the business: Both structures work fine for most business sales, but buyers sometimes prefer the simplicity of asset purchases from LLCs rather than dealing with S corp stock sales.

Which One Should You Pick?

Here’s our framework based on thousands of business formations:

Freelancer or solo consultant earning under $60,000 net: Regular LLC. The tax savings don’t justify the extra complexity and costs.

Small business with 2-3 partners: Regular LLC initially. You want maximum flexibility to figure out profit-sharing and roles. Consider S corp election after you’re consistently profitable above $80,000.

Profitable service business earning $80,000+ net: LLC with S corp election. The tax savings typically outweigh the additional compliance costs.

Planning to raise venture capital: Regular LLC that you can convert to C corp later. Don’t box yourself in with S corp restrictions.

E-commerce or online business: Regular LLC initially. Your income might be volatile while you’re growing, and you want flexibility. Switch to S corp election once you have consistent high profits.

Real estate investment: Regular LLC. Rental income doesn’t count as earned income for self-employment tax purposes anyway, so S corp election provides no benefit.

Can You Switch Later?

Yes, and it’s common. You can start with a regular LLC and elect S corp taxation later by filing Form 2553. This election is typically effective the following tax year, though there’s a late-election relief procedure if you miss the deadline.

You can also convert an LLC to a C corporation, though this gets more complex from a tax perspective. Many businesses start as LLCs and convert to C corps when they’re ready to raise venture capital.

Going the other way is harder. Once you’ve elected S corp taxation, you generally can’t revoke it for five years without IRS permission.

For International Founders

If you’re not a U.S. citizen or permanent resident, regular LLC taxation is usually your only option. S corp elections require all owners to be U.S. persons.

However, LLCs can create some complications for international founders because of how they’re treated under various tax treaties. Some countries don’t recognize LLCs as corporations, which can lead to double taxation issues.

Many international founders start with C corporations to avoid these complications, especially if they plan to eventually move to the U.S. or raise money from U.S. investors.

Frequently Asked Questions

Can I elect S corp taxation immediately when forming my LLC?
Yes, but you need to file Form 2553 within 75 days of forming your LLC (or by March 15th of the tax year you want the election to be effective).

What’s a “reasonable salary” and how is it determined?
It should reflect what you’d pay someone else to do your job. The IRS looks at industry standards, your qualifications, and the time you spend working. A marketing consultant might need to pay themselves $50,000-70,000, while a specialized surgeon operating a medical practice might need $200,000+.

Do I need separate bank accounts for an LLC taxed as S corp?
You should maintain separate business and personal accounts regardless of tax election. It’s required for liability protection and makes accounting much easier.

Can I still deduct business expenses with S corp taxation?
Yes, business expenses are still deductible. Some fringe benefits (like health insurance premiums) might actually be more favorable with S corp taxation.

What happens if I don’t pay myself a salary?
The IRS can reclassify your distributions as wages, meaning you’ll owe back payroll taxes plus penalties and interest. Don’t try to game the system by paying yourself $1 — it won’t work.

Can I make the S corp election for just part of the year?
The election typically applies to the full tax year. If you make the election mid-year, you might need to file a short-period S corp return, which gets complicated quickly.

What if my business loses money some years?
You’re not required to pay yourself a salary if the business isn’t profitable. The “reasonable salary” requirement only applies when there are profits to distribute.

Can I switch from S corp election back to regular LLC taxation?
Yes, but you generally have to wait five years unless you get IRS permission. The switch happens by revoking the S corp election.

Conclusion

The choice between regular LLC taxation and S corp election comes down to your profit level and complexity tolerance. If you’re consistently earning over $80,000 in net profit and can handle the additional paperwork, the S corp election will likely save you thousands in self-employment taxes.

For most new businesses, starting with a regular LLC gives you maximum flexibility while you figure out your business model and growth trajectory. You can always elect S corp taxation later once the numbers make sense.

Ready to get started? We help entrepreneurs form LLCs in all 50 states, handle the S corp tax election paperwork, and provide ongoing compliance support to keep you on track. Our platform walks you through entity selection, state filing, EIN registration, and everything else you need to get your business legally established. [Get started with your business formation today](https://www.businessformations.com/get-started/) — we’ll help you pick the right structure and handle the paperwork so you can focus on growing your business.