S-Corp vs Sole Proprietor: when does the election save tax?

For US business owners, the most consequential tax decision after “should I incorporate at all?” is “should I elect S-Corp status?” The election can save thousands a year in self-employment tax — or cost you more than it saves. Here's how the math really breaks down in 2025-26.

The mechanics

A sole proprietor (or single-member LLC) pays 15.3% self-employment tax on every dollar of net profit up to the Social Security wage base ($176,100 in 2025, $184,500 in 2026), then 2.9% Medicare on the rest, plus 0.9% Additional Medicare above $200k single / $250k MFJ.

An S-Corp splits the same income two ways:

• A W-2 salary to the owner-employee — subject to FICA (15.3% combined, owner pays both halves through the company).
• The remaining profit as a distribution on Schedule K-1 — no FICA, no SE tax.

That distribution slice is the entire benefit: 15.3% of it stays with you instead of going to payroll tax.

Reasonable compensation — the audit risk

The math: when it works

Two things make the election worthwhile:

• A profit big enough that FICA savings exceed the admin cost.
• A role where a reasonable salary leaves a meaningful distribution slice.

Typical admin cost: $3,500–$5,000 a year for a payroll service, the corporate tax return (Form 1120-S), state fees, and quarterly federal/state filings. Most small operators break even somewhere around $60,000–$80,000 of net profit.

A worked example: $150,000 net profit

The headline saving of nearly $9,000 looks great until you net the lost QBI deduction (W-2 wages to an owner are excluded from qualified business income, while sole-prop profit is fully eligible) and the admin overhead. The real-world net at $150k is much thinner — and at $80k the equation tips the wrong way.

The QBI interaction

OBBBA made the §199A deduction permanent: 20% of qualified business income, subject to phase-in above $403,500 MFJ / $201,750 single (2026 figures). For S-Corp owners, every dollar paid as W-2 salary reduces QBI by a dollar; for sole proprietors, the entire net SE profit is eligible. Below the income threshold this typically favours sole prop; above it, the S-Corp can actually win because the W-2 wage limit can rescue a QBI deduction the sole prop would lose.

State considerations

How to make the election

An LLC files Form 2553 directly (Part IV handles the entity-classification box; no separate Form 8832 needed). The deadline is two months and fifteen days after the start of the tax year you want the election to apply — 15 March for calendar-year filers. Miss it and Rev. Proc. 2013-30 lets you make a late election up to three years and 75 days late, with a reasonable-cause statement and consistent filings.

When NOT to elect

• Profit below ~$80k — admin cost eats the saving.
• Reasonable comp is almost all the profit (e.g., $140k of $150k) — there's nothing left to take as distribution.
• California small operators — the 1.5% net-income tax plus the $800 minimum often offsets federal savings.
• Passive or investment income — there's no SE tax to avoid in the first place.
• You want maximum Social Security credit — lower wages mean a smaller eventual benefit.