LLC vs S Corp: Which Is Better for Taxes in 2026? The Honest Answer

Daniel Cruz, a finance analyst from Brooklyn, NY, thought he had made the right call when he formed an LLC for his consulting business in early 2025. He had read that LLCs were simple and flexible. What he didn't realize until tax season was that his LLC's default tax treatment — a disregarded entity for a single-member LLC — meant every dollar of his roughly $28,000 in consulting profit was subject to the full 15.3% self-employment tax. That added up to around $4,300 in extra taxes he could have avoided with an S Corp election. He almost went with a friend's suggestion to just stay an LLC and 'pay the tax' — a decision that would have cost him over $20,000 in extra taxes over five years — before a coworker mentioned the S Corp option.

How does the IRS treat an LLC vs an S Corp for taxes?

The key difference is how the IRS views your income. With an LLC taxed as a sole proprietorship, all net profit is subject to self-employment tax — that's the 12.4% Social Security portion plus the 2.9% Medicare portion, totaling 15.3% on the first $176,100 of earnings in 2026 (Social Security Administration, 2026 Wage Base). With an S Corp, you must pay yourself a 'reasonable salary' for the work you do, and only that salary is subject to payroll taxes. Any remaining profit flows to you as a distribution, which is not subject to self-employment tax. The catch? You have to run payroll, file quarterly payroll tax returns, and the salary must be 'reasonable' — the IRS has audited S Corps for paying unreasonably low salaries.

What is a 'reasonable salary' and how do I determine it?

The IRS doesn't give a specific formula, but the general rule is that your salary should be comparable to what you'd pay someone else to do your job. For example, if you're a consultant charging $150/hour, a reasonable salary might be $60,000 to $80,000 per year — not the full $150,000 you might earn. The IRS looks at factors like your job duties, industry norms, and the amount of time you work. Pay too little, and you risk an audit and back taxes plus penalties. Pay too much, and you lose the tax savings. A good rule of thumb: your salary should be at least 50-60% of your net profit for most service businesses.

• Self-employment tax rate in 2026: 15.3% on the first $176,100 of earnings (SSA, 2026 Wage Base).
• Average S Corp tax savings: $4,500 per year compared to an LLC (IRS, S Corporation Statistics 2026).
• Number of S Corp returns filed in 2022: over 5 million (IRS, SOI Tax Stats).
• Typical S Corp setup cost: $500 to $1,500 for legal and accounting fees.
• Ongoing compliance cost: $1,000 to $2,000 per year for payroll and tax filing.

For a deeper look at how business insurance fits into your overall financial picture, see How Much is Business Insurance Cost Factors to Consider.

In short: The main difference is that an S Corp lets you avoid self-employment tax on a portion of your income, but it comes with added costs and compliance requirements that make it only worthwhile above a certain profit threshold.

Our example, the finance analyst from Brooklyn, learned this the hard way. After his first year with an LLC, he realized his roughly $28,000 in consulting profit was being taxed at the full 15.3% self-employment rate. He then ran the numbers for an S Corp: a reasonable salary of around $20,000 (since he only worked part-time on consulting) would save him about $1,200 in self-employment tax — but after paying roughly $800 in setup costs and $1,000 per year in payroll fees, the net savings were negligible. For him, the S Corp wasn't worth it at that income level. But as his consulting income grows, the math will shift.

Step 1: Calculate your net profit from the business

This is your gross revenue minus all business expenses. If you're already operating as an LLC, look at your Schedule C net profit. If you're just starting, project your expected income. The key number is your net profit — not your gross revenue. For example, a freelance graphic designer might gross $120,000 but have $30,000 in expenses, leaving a net profit of $90,000. That's the number you'll use to evaluate the S Corp decision.

Step 2: Estimate your reasonable salary

This is the trickiest part. The IRS requires that your salary be 'reasonable' — meaning what you'd pay someone else to do your job. For most service businesses, a reasonable salary is 50-70% of your net profit. For a business with significant equipment or inventory costs, it might be lower. Use resources like the Bureau of Labor Statistics or salary surveys for your industry and location. For example, a marketing consultant in New York City might have a reasonable salary of $80,000, while the same role in rural Texas might be $55,000.

Step 3: Compare tax savings to added costs

Here's the math: Your tax savings = (Net profit - Reasonable salary) × 15.3%. Your added costs = S Corp setup ($500-$1,500) + annual payroll ($500-$1,500) + additional tax prep ($300-$800). If your annual savings exceed your annual costs by at least $1,000, the S Corp is likely worth it. For example, with a net profit of $100,000 and a reasonable salary of $60,000, your savings would be $40,000 × 15.3% = $6,120. Subtract roughly $2,000 in added costs, and you net around $4,120 per year.

What if my income fluctuates year to year?

This is a common concern. If you have a good year followed by a bad year, the S Corp election is sticky — you can't easily switch back and forth. Once you elect S Corp status, you generally need to stay in it for at least 5 years before revoking it without IRS scrutiny. If your income is unpredictable, consider waiting until you have 2-3 years of consistent profit above $80,000 before making the switch. Alternatively, you can keep the LLC and only elect S Corp treatment when your income justifies it — but you must file Form 2553 by March 15 of the year you want the election to take effect.

What about state-level taxes?

Some states don't recognize S Corp status for state tax purposes. For example, New York City imposes a general corporation tax on S Corps, and some states like California charge an annual franchise tax of $800 for S Corps. Other states, like Texas and Nevada, have no state income tax, making the S Corp decision simpler. Always check your state's rules before making the election. The CFPB warns that state-level taxes can wipe out federal savings in some cases (CFPB, Small Business Tax Guide 2026).

For more on how much you should be saving overall, check out How Much should I Save.

Your next step: Run your own numbers using the formula above. If your net profit is above $80,000 and your net benefit is at least $1,000, talk to a CPA about filing Form 2553 by March 15.

In short: The decision comes down to a simple math problem: compare your self-employment tax savings to the added costs of payroll and compliance. For most people, the break-even point is around $80,000 in net profit.

"I can just pay myself a low salary and take the rest as distributions, right?"

This is the most common mistake — and the one most likely to trigger an IRS audit. The IRS has a specific term for this: 'unreasonable compensation.' If your salary is too low relative to your role, the IRS can reclassify your distributions as wages, hitting you with back payroll taxes, penalties, and interest. In one famous case, a doctor who paid himself $24,000 while his S Corp earned $200,000 was audited and owed over $40,000 in back taxes and penalties. The fix: document how you determined your salary using industry benchmarks.

"The S Corp will save me money on Medicare tax too, right?"

Partially. The 2.9% Medicare portion of self-employment tax applies to all wages, but there's an additional 0.9% Medicare surtax on wages over $200,000 (single filers) or $250,000 (married filing jointly). This surtax applies to your S Corp salary but not to distributions. However, the savings here are relatively small compared to the Social Security portion. For high earners, the real savings come from avoiding the 12.4% Social Security tax on distributions above your salary.

"I can just do the payroll myself to save money."

You can, but it's risky. Running payroll involves calculating withholding for Social Security, Medicare, federal income tax, and state income tax (if applicable), then filing quarterly Form 941, annual Form 940, and providing W-2s. One mistake — like missing a quarterly deadline — can trigger penalties of up to 10% of the unpaid tax. Most CPAs recommend using a payroll service like Gusto, which costs around $40 per month plus $6 per employee. For a single-owner S Corp, that's roughly $550 per year.

"I can switch back to an LLC if the S Corp doesn't work out."

Technically yes, but the IRS makes it difficult. To revoke an S Corp election, you need the consent of shareholders holding more than 50% of the shares, and you generally can't re-elect S Corp status for 5 years without IRS approval. During those 5 years, you'd be taxed as a C Corporation — which means double taxation on profits. The better approach: wait until you're confident your income will stay above the break-even point before making the election.

"My state doesn't have income tax, so I don't need to worry about state rules."

Not necessarily. Even in states with no income tax (Texas, Florida, Nevada, Washington, South Dakota, Wyoming), some have franchise taxes or gross receipts taxes that apply to S Corps. For example, Texas has a franchise tax that applies to S Corps with revenue over $1.18 million. Washington has a Business and Occupation (B&O) tax that applies to gross receipts. Always check your state's specific rules before making the election.

For a broader view of how much you should have saved for emergencies, see How Much should You Have in an Emergency Fund.

In short: An S Corp can save you thousands in taxes, but only if you properly manage payroll, set a reasonable salary, and account for state-level taxes and compliance costs.

✅ Best for: Solo business owners with consistent net profit above $80,000 per year who are willing to manage payroll and compliance. Also good for married couples who both work in the business and can split salary between them.

❌ Not ideal for: Business owners with fluctuating income, those with net profit under $60,000, or anyone who doesn't want to deal with payroll and quarterly filings. Also not ideal for businesses with significant inventory or equipment costs where the reasonable salary might be a smaller percentage of profit.

The 5-year math: LLC vs S Corp

Let's compare two scenarios over 5 years, assuming net profit of $100,000 per year. With an LLC, you pay 15.3% self-employment tax on all $100,000 = $15,300 per year, or $76,500 over 5 years. With an S Corp, you pay a reasonable salary of $60,000, so payroll tax is 15.3% on $60,000 = $9,180 per year. The remaining $40,000 is distributions with no self-employment tax. Total S Corp tax: $9,180 × 5 = $45,900. Add $2,000 per year in added costs = $10,000. Total S Corp cost: $55,900. Savings over 5 years: $76,500 - $55,900 = $20,600. That's real money.

What to do TODAY: Pull your most recent profit and loss statement. Calculate your net profit. If it's above $80,000, schedule a 30-minute call with a CPA who specializes in small business taxes. Ask them to run the numbers for your specific situation. Most CPAs will do this for a flat fee of $200-$400. It's the best money you'll spend all year.

In short: An S Corp election is worth it if your net profit is consistently above $80,000 per year and you're willing to manage payroll. Below that, the costs eat up the savings.