If you're self-employed or own a small business, the S Corp election is one of the most impactful tax decisions you'll make. Get it right and you could save $10,000+ per year in self-employment taxes. Get it wrong — or ignore it entirely — and you're leaving serious money on the table.
The Self-Employment Tax Problem
When you're a sole proprietor or single-member LLC, all of your net business income is subject to self-employment tax (Social Security and Medicare) at 15.3% on top of your regular income tax.
On $150,000 of net income, that's roughly $23,000 in self-employment tax alone. That's before a dollar of income tax.
How the S Corp Election Helps
When you elect S Corp status, you pay yourself a "reasonable salary" and take the remaining profits as distributions. Only the salary portion is subject to payroll taxes. The distributions are not.
If your business earns $150,000 and you pay yourself a $70,000 salary, only the $70,000 is subject to payroll taxes. The remaining $80,000 passes through as a distribution — still taxed as income, but free from the 15.3% self-employment tax.
That's roughly $12,000 in annual tax savings.
The "Reasonable Salary" Requirement
The IRS requires that S Corp owners who perform services for the business pay themselves a reasonable salary. You can't pay yourself $10,000 and take $140,000 as distributions. That's a red flag that invites an audit.
"Reasonable" means comparable to what someone in a similar role and industry would earn. There's some flexibility here, but don't get greedy.
When It Doesn't Make Sense
The S Corp election adds complexity: separate tax returns, payroll administration, and compliance requirements. If your business income is below $50,000-$60,000, the tax savings may not justify the additional costs.
There are also situations where the S Corp structure interacts poorly with other tax strategies — like the Qualified Business Income (QBI) deduction. The lower your salary, the higher your QBI deduction, but the IRS reasonable salary rules limit how low you can go.
The Bottom Line
If you're self-employed with net income above $60,000 and you haven't evaluated the S Corp election, you're almost certainly overpaying on taxes. Talk to a CPA who understands small business tax planning — this isn't something to DIY based on a blog post.
But now you know the right questions to ask.