S-Corp vs LLC: The $9,000 Decision You Might Be Getting Wrong

Every April, a Houston consultant watches $18,000 leave their bank account for self-employment taxes alone. Income tax comes on top of that.

The consultant down the street, earning the same $120,000, pays $9,000 in self-employment taxes. Same income. Same work. Different tax structure.

The difference? One elected S-Corp status. The other didn’t.

This isn’t a loophole. It isn’t aggressive tax planning. It’s understanding how the tax code treats different business structures, then choosing appropriately.

The Misconception First

S-Corp is not a business structure. It’s a tax election.

You don’t choose between forming an LLC or an S-Corp. You form an LLC, then decide how to be taxed. You can be taxed as a sole proprietorship (the default), a partnership (for multi-member LLCs), an S-Corp (by election), or even a C-Corp (rare for small businesses).

The liability protection stays the same regardless of tax election. The tax treatment is what changes.

How a Standard LLC Is Taxed

A single-member LLC is a “disregarded entity” for tax purposes. The IRS pretends the LLC doesn’t exist. All income flows directly to your personal return on Schedule C.

The self-employment tax problem:

All net profit from your Schedule C is subject to self-employment tax: 15.3% on the first $176,100 (2025), then 2.9% above that.

This is Social Security and Medicare combined. When you’re an employee, you pay half and your employer pays half. When you’re self-employed, you pay both halves.

Example: $120,000 net profit as LLC

Self-employment tax: $120,000 x 15.3% = $18,360

That’s before income tax. Just the SE tax alone.

How S-Corp Taxation Works

With S-Corp election, you become an employee of your own business. You pay yourself a reasonable salary through payroll. The remaining profit is distributed to you as dividends.

Here’s the key: Only your salary is subject to employment taxes. The distribution is not.

Example: $120,000 net profit as S-Corp with $60,000 salary

Payroll taxes on salary: $60,000 x 15.3% = $9,180 Employment taxes on distribution: $0

Total employment taxes: $9,180

Savings: $9,180 per year

That’s real money. At $120,000 of profit, the S-Corp election typically saves roughly $9,000 annually in self-employment taxes.

The Reasonable Salary Requirement

You can’t pay yourself $1 and take the rest as distribution. The IRS requires a “reasonable salary” for S-Corp owner-employees.

Factors the IRS considers:

What similar businesses pay for similar work
Your education and experience
Time devoted to the business
Business revenue and profitability
Geographic location

A Houston business owner working full-time, generating $150,000 in profit, with a $40,000 salary would face scrutiny. That’s unreasonably low for full-time executive work.

General guideline: Salary is typically 40-60% of net profit, adjusted for industry norms and circumstances. Higher percentages for professional services where the owner is the primary revenue generator. Lower percentages for businesses where passive income or other employees generate significant value.

The Compliance Cost Reality

S-Corp saves taxes but adds expenses and administrative burden:

Payroll Administration

You must run formal payroll:

Process paychecks (at least monthly is typical)
Withhold federal income tax, Social Security, Medicare
File Form 941 quarterly
Pay state unemployment taxes
Issue W-2 by January 31

Cost: DIY payroll software: $500-1,000/year. Outsourced payroll service: $1,200-2,400/year.

Separate Tax Return

S-Corps file Form 1120-S, a separate business return, even though income passes through to your personal return. This is in addition to your 1040.

Cost: S-Corp tax preparation typically adds $500-1,500 to your tax prep fees compared to Schedule C.

Total Compliance Overhead

Budget $1,500-3,000 annually for S-Corp compliance (payroll + additional tax prep).

When S-Corp Makes Financial Sense

The math is straightforward: SE tax savings must exceed compliance costs.

Annual Net Profit	Estimated SE Tax Savings	Compliance Costs	Net Benefit
$40,000	~$3,000	~$2,500	~$500
$60,000	~$5,000	~$2,500	~$2,500
$80,000	~$6,500	~$2,500	~$4,000
$100,000	~$8,000	~$2,500	~$5,500
$150,000	~$11,000	~$2,500	~$8,500

General threshold: S-Corp typically makes sense when net profit consistently exceeds $50,000-60,000 annually. Below that, savings are marginal or negative after compliance costs.

When S-Corp Doesn’t Make Sense

Income Too Low

At $30,000-40,000 net profit, compliance costs eat most or all of the savings. Stick with standard LLC until income grows.

Highly Variable Income

If you earn $150,000 one year and $30,000 the next, managing reasonable salary becomes complicated. The administrative burden may not be worth it.

Planning to Sell Soon

S-Corp taxation can complicate business sales and create unexpected tax consequences on exit. If you’re selling within 1-2 years, evaluate carefully with your CPA.

Passive Income Businesses

If you’re not actively involved in the business, the IRS may challenge whether you’re entitled to split income between salary and distributions.

You Value Simplicity

Some business owners prefer simplicity over optimization. That’s a valid choice. Standard LLC is simpler. Period.

How to Elect S-Corp Status

The Process

File Form 2553 with the IRS.

Timing: To be effective for the current tax year, file by March 15. For new LLCs, file within 75 days of formation. Late elections are sometimes accepted with reasonable cause.

Texas Considerations

Texas has no state income tax, so S-Corp election is purely a federal strategy here.

Texas does have a franchise tax, but it only applies to businesses exceeding $2.47 million in total revenue (2025). Most small businesses fall below this threshold and effectively pay nothing.

The Decision Framework

Elect S-Corp if:

Net profit consistently exceeds $60,000
You’re actively working in the business
Income is relatively stable year to year
You’re comfortable with payroll administration
You plan to maintain the business long-term

Stay Standard LLC if:

Net profit is under $50,000
Income is highly variable
You value simplicity over optimization
You’re planning to sell or exit soon
The business is largely passive

Running Your Numbers

Before deciding, model your specific situation:

Calculate current self-employment tax on your net profit
Estimate reasonable salary (typically 40-60% of net profit)
Calculate SE tax savings from the difference
Subtract estimated compliance costs
Determine net benefit

If the net benefit is $2,000+, S-Corp likely makes sense. If it’s under $1,000, the hassle may not be worth it.

Getting It Right

The S-Corp vs LLC decision affects your taxes, your administrative burden, and potentially your exit strategy. It’s worth getting professional input.

At EZQ Group, we help Houston business owners run the numbers, handle S-Corp elections, manage payroll, and maintain the clean books necessary for compliance. We’ve seen the savings and the pitfalls across hundreds of clients.

Ready to find out if S-Corp makes sense for you? Contact us for a tax planning consultation.

This article provides general information and is not tax advice. Tax situations vary, and you should consult with a qualified tax professional about your specific circumstances.