If you run a small business, someone has probably told you to “just become an S-corp.” It is common advice, and sometimes it is right. But the election has real costs, and the point where it starts paying off comes later than most people expect. Here is the decision without the jargon.
An LLC is a legal wrapper, not a tax status
By default, a single-member LLC is taxed exactly like a sole proprietorship. All the profit flows to your personal return, and it is subject to self-employment tax on top of ordinary income tax. The LLC protects your personal assets. On its own, it does not lower your tax bill at all.
That surprises a lot of owners, because forming the LLC felt like the big step. It was, legally. It just was not a tax move.
What the S-corp election actually changes
An S-corp election tells the IRS to treat your business as a corporation that pays you a salary. You pay payroll taxes on that salary, but the remaining profit passes through to you free of self-employment tax. The gap between a reasonable salary and your total profit is where the savings live.
The catch is that the election brings obligations that cost money whether or not you save any:
- You must run real payroll, with withholding and quarterly filings.
- You must file a separate corporate return each year.
- In California you owe the annual franchise tax and a state-level S-corp tax on net income.
Those costs are largely fixed. At low profit they can swallow the savings completely, which is why the election is not automatically a good idea just because it is available.
The question is never “is it better,” it is “at what profit”
For most California businesses the election starts to make sense somewhere in the range of moderate, consistent annual profit, once the payroll and filing costs are comfortably outweighed. The exact figure is different for every business, because it depends on your profit, on what counts as a reasonable salary for the work you actually do, and on what your state filings cost.
Consistency matters as much as size. An election made in a strong year still carries its costs in a weak one.
Two things people forget
First, the IRS requires your salary to be reasonable for your role. Paying yourself an artificially low salary to shift more profit into the untaxed bucket is exactly the thing that draws scrutiny.
Second, the election interacts with your retirement contributions and with the qualified business income deduction. A change that looks like a saving in one column can cost you in another. That is why the whole picture has to be modelled before anyone recommends it.
What we do
We run your actual numbers, both ways, and tell you honestly whether the election pays off for you this year. If it does not, we say so. The consultation costs nothing.
Sources
- IRS, S Corporations: irs.gov, S corporations
- IRS, Self-Employment Tax: irs.gov, self-employment tax
- California Franchise Tax Board, Corporations: ftb.ca.gov, corporations