The self-employment tax on $150,000 of net profit runs roughly $21,000. Most service business owners pay it and move on. Some of them could cut that number by $8,000 to $12,000 a year with a single IRS election. Whether you are in that group comes down to one calculation that takes about ten minutes once you have the right numbers in front of you.

What the S Corp election actually does

When your LLC is taxed as a sole proprietorship or partnership by default, all your net profit is subject to self-employment tax. The statutory SE tax rate is 15.3% on earnings up to the Social Security wage base (which the IRS adjusts annually). Above the wage base, the Medicare rate is 2.9%, plus an additional 0.9% on net self-employment earnings above the applicable filing-status threshold ($200,000 for single filers). On $150,000 of net profit, which falls below the wage base, the surtax does not apply; the SE tax bill works out to approximately $21,000 because the IRS allows you to compute the tax on 92.35% of net profit rather than the full amount.

An S Corp election changes the structure of how profit reaches you, not the underlying legal entity. You can remain an LLC under state law while electing S Corp status with the IRS. Inside that structure, profit flows two ways: a W-2 salary and a distribution. FICA, the payroll tax equivalent of SE tax, applies to the salary at the same combined 15.3% rate. The distribution comes to you without that tax attached.

That gap is the whole game.

If your net profit is $150,000 and you set your salary at $70,000, you owe SE-equivalent tax on $70,000 instead of the full amount. The remaining profit flows as a distribution, clear of self-employment tax. Self-employment tax on $150,000 is about $21,200, while payroll tax on a $70,000 salary is about $10,700, so the savings are roughly $10,500 before accounting for overhead. All figures here are illustrative; your actual savings depend on the current Social Security wage base, what qualifies as a reasonable salary for your specific role, and your precise profit level.

What the additional overhead actually costs

The S Corp election is not free to maintain. You need a payroll. As a W-2 employee of your own company, you are responsible for quarterly payroll tax deposits and filings, a year-end W-2, and state unemployment insurance on your own wages. A payroll service for a single-owner operation typically runs somewhere between $500 and $1,200 per year, though this varies by provider and volume.

You also need a separate tax return. An S Corp files Form 1120-S each year in addition to your personal return. Most accountants charge several hundred dollars to well over a thousand dollars more for that return than for a Schedule C or partnership return, depending on complexity.

Added together, the additional annual overhead for running a single-owner S Corp in the $1,500 to $3,000 range is a reasonable illustrative estimate. Your situation may be meaningfully different in either direction.

The break-even is straightforward: if the SE tax savings on your expected distributions exceed the overhead, the election makes financial sense. On roughly $10,500 of estimated savings against $2,000 in overhead, the net advantage is about $8,500 a year. On a smaller spread, it disappears quickly.

When staying an LLC is the right call

The S Corp numbers look compelling until you run them on a smaller business.

If your net profit is $40,000 a year, a defensible salary for most professional service roles would consume most of that profit. There is little or no distribution left to shield from SE tax, so the election costs you $1,500 to $3,000 in overhead and buys you almost nothing. Early-stage businesses face this same problem compounded by the fact that their revenue has not stabilized yet, which makes the fixed payroll overhead harder to absorb in a low year.

Income volatility is its own problem. A single-owner S Corp still needs payroll infrastructure running even when profit is thin. That fixed overhead costs you something every year, whether profit supports it or not.

And consider the salary math on a business that looks large enough to clear the threshold but probably is not: if your net profit runs at, say, $60,000 and your role genuinely commands a $52,000 market-rate salary, you are shielding only $8,000 from SE tax. The savings come to roughly $500 per year, which does not cover the overhead.

For most businesses with net profit below roughly $80,000, and honestly for many businesses above that range depending on the salary question, the LLC stays right.

The reasonable salary question

The IRS requires S Corp owner-employees who work in the business to pay themselves a reasonable salary based on fair market compensation for their role. There is no published formula. What is reasonable depends on what you would pay an arm's-length employee to do the same work, your billing rate, industry compensation benchmarks, and what similar businesses pay people in comparable positions.

Underpaying yourself to shift as much profit as possible into distributions is a well-documented audit trigger. The IRS publishes specific guidance on S Corp owner compensation and examines this question regularly in audits. A defensible salary is one you can support with data, not the lowest number that passes a quick read.

Setting the salary too high, on the other hand, erodes the benefit. If reasonable compensation for your role is $95,000 and your profit is $110,000, you are shielding only $15,000 from SE tax and saving roughly $1,000 per year, which does not cover the overhead.

A note for Washington business owners

Washington does not tax wage or business income today, which keeps the S Corp analysis cleaner than in states like California or New York. In those states, the S Corp election also shifts income between tax buckets in ways that can affect state income tax liability and add another layer to the calculation. In Washington, the federal SE tax savings is the primary driver, full stop.

Washington B&O tax is unaffected by the S Corp election. You owe B&O on your gross receipts based on your business activity classification regardless of whether you file a Schedule C, a Form 1065, or a Form 1120-S. The entity election is a federal income tax decision; it does not change how the state taxes your business.

How to run the calculation yourself

Start with your average annual net profit over the last two to three years. Use the number you expect to sustain, not your best year. Then estimate a defensible salary for your role by looking at what firms in your field pay experienced employees doing comparable work. Subtract that salary from your average profit. That remainder is your estimated annual distribution.

Estimate your self-employment tax on the full profit (about 14.1% of net profit, below the Social Security wage base) and subtract the payroll tax on your salary (15.3%). The difference is your rough savings. Subtract your anticipated overhead for payroll administration and the additional return. If the result is meaningfully positive, the election deserves a real conversation with your accountant. If it is near zero or negative, the LLC stays the right call until your profit grows.

The election deadline is generally by March 15 of the current calendar year for an existing business on a calendar year, though late-election relief is available in certain circumstances and the specific deadline depends on when your entity was formed and other factors. If you are thinking about next year, fall is a reasonable time to start the conversation.

If you are already paying for ongoing accounting and tax planning, this analysis should be part of that engagement rather than a separate project. At Caro & Associates, it is the kind of forward-looking calculation we run as a standard part of tax advisory work. Our tax planning page covers what that looks like in practice, and our pricing page shows what ongoing advisory costs. If the monthly accounting cost question is where you want to start, here is how that pricing breaks down for small businesses.

Questions owners ask about this

What is the difference between an LLC and an S Corp?

An LLC is a legal entity type that protects your personal assets from business liabilities. An S Corp is a federal tax classification, not a separate legal entity. You can have an LLC that is taxed as an S Corp. The two operate on different tracks: your state sees an LLC, the IRS sees an S Corp. Many owners confuse them because the decision involves both.

How much do I need to earn before an S Corp election makes sense?

There is no universal threshold, but for most Washington service businesses the savings outweigh the overhead somewhere around $80,000 or more in annual net profit, and later if a reasonable salary for your role is close to your profit. The actual number depends on what a reasonable salary is for your role, what it costs to run a separate payroll, and what your accountant charges to file the additional S Corp return. Run the calculation with your specific numbers before deciding.

Does an S Corp election affect my Washington B&O tax?

No. Washington B&O tax applies to your gross receipts regardless of entity structure. The S Corp election is a federal income tax decision; it does not change how the state classifies or taxes your business activity. Your B&O classification and rate depend on the nature of your work, not on how you have structured the entity.

Can I switch back from S Corp taxation if it stops making sense?

You can revoke an S Corp election, but IRS rules restrict how soon you can re-elect after a revocation, and the paperwork involves your accountant's time. This is one reason to be confident in the math before making the switch rather than treating it as easily reversible year to year.

How does the IRS determine what counts as a reasonable salary?

The IRS does not publish a formula. Reasonable salary is based on what you would pay a comparably skilled arm's-length employee to do the same work. Relevant factors include industry compensation data, your billing rate, and what similar businesses pay owner-operators. An accountant familiar with your field can help you land on a number that holds up to scrutiny.