Is an S-Corp Worth It? 5 Questions to Ask for Big Savings

I get asked "Is an S-Corp worth it?" a lot by our tax clients. Many small business owners hear about potential tax savings and wonder if they should make the switch from their current setup, which usually means an LLC.

The short answer is that the S-Corp election makes sense when you're earning enough profit for the tax savings to outweigh the additional costs and complexity. But there's a lot more to consider than just your income level. Here's everything you need to know! 

🧾PSSST! For a quick answer if you should make a switch to an S-Corp based on your profits, use this FREE S-Corp calculator! 

What Is an S-Corp?

An S-Corp is NOT a business entity you can form at the state level. You can't walk into your secretary of state's office and file paperwork to create an "S-Corporation."

Instead, S-Corp is a tax election you make with the IRS.

You're telling the government, "Please tax my existing business as if it were an S-Corporation." This election changes how the IRS treats your business income for tax purposes.

Most small business owners who make this election already have an LLC. They keep their LLC structure but ask the IRS to tax it like an S-Corp. You get the operational flexibility of an LLC with the tax benefits of S-Corp status.

Is an S-Corp a Business Structure?

No, an S-Corp is a tax structure, not a business entity.

You maintain your existing business structure (usually an LLC, a limited liability company) but file Form 2553 with the IRS to elect S-Corp taxation. Your state paperwork doesn't change. Your operating agreement stays the same. You're simply changing your tax treatment.

C-Corporations can also elect S-Corp status, though this is less common for small businesses. C-Corps come with more regulatory requirements and are typically used by larger companies planning to raise significant capital or go public.

What Is the Main Benefit of an S-Corp?

The primary benefit is self-employment tax savings.

As a sole proprietor or LLC owner, you pay self-employment tax (Social Security and Medicare taxes) on all your business profits. That's 15.3% on top of your regular income taxes.

With S-Corp election, you split your profits into two categories:

• Reasonable salary (subject to payroll taxes)

• Distributions (not subject to self-employment tax)

Let's say your business profits $100,000. As a sole proprietor, you'd pay self-employment tax on the full amount. With the S-Corp election, you might pay yourself a $60,000 salary (subject to payroll taxes) and take $40,000 as distributions (no self-employment tax).

You save about $6,120 in self-employment taxes!

The savings increase as your profits grow, making the S-Corp tax status particularly attractive for businesses earning $60,000+ in annual profit.

Related Article: What Is the Difference Between Payroll and Income Taxes?

Is It Worth Setting Up an S-Corp?

S-Corp election isn't automatically the right choice for every profitable business. You need to weigh the tax advantages against the additional costs and complexity. 

Here are the key questions that determine whether S-Corp election makes financial sense for your situation:

1. Are you making enough profit to justify the additional costs?

S-Corp election comes with extra expenses. You'll need payroll processing, additional tax preparation fees, and potentially bookkeeping costs to handle payroll accounting.

Your tax savings need to exceed these costs by a meaningful margin to justify the switch. Most of the time, this means having at least $60,000 in annual business profit before considering S-Corp election, though the exact threshold depends on your specific circumstances.

2. Can you afford to pay yourself a reasonable salary?

The IRS (Internal Revenue Service) requires S-Corp owners who work in their business to pay themselves a "reasonable salary" for the work they perform. In other words, you can't pay yourself $20,000 when similar professionals in your industry earn $80,000. That'd be unreasonable.

This salary requirement creates a cash flow consideration. You need enough consistent income to cover payroll every month with reasonable compensation. For many small businesses, especially in the early years, this can create a lot of stress.

3. Do you have consistent, predictable income throughout the year?

Payroll runs on a schedule regardless of when your clients pay. If your income fluctuates dramatically month to month, meeting regular payroll obligations becomes challenging.

Seasonal businesses or those with irregular revenue streams often struggle with S-Corp requirements. You need enough cash flow predictability to confidently commit to monthly salary payments.

4. Are you comfortable with increased administrative responsibilities?

S-Corp election adds ongoing administrative tasks to your plate. You'll file quarterly payroll reports, issue yourself a W-2 annually, and maintain payroll records. Your tax returns become more complex, often requiring professional preparation.

These aren't insurmountable challenges, but they require consistent attention throughout the year to pay taxes in the right way.

5. Will you have enough profit left after paying your salary to make the tax savings worthwhile?

After paying yourself a reasonable salary, you need enough remaining profit to generate meaningful tax savings. If your entire profit gets absorbed by your required salary, S-Corp election provides no benefit.

The sweet spot is usually when your reasonable salary represents 60-70% of your total business profit, leaving 30-40% available as tax-advantaged distributions. You'll pay payroll taxes on your reasonable salary, but not on the distributions, which'll help reduce your tax burden.

So, When Is an S-Corp Worth It?

Generally speaking, an S-Corp election is worth it when your business consistently generates enough profit beyond what you'd pay yourself as a reasonable salary.

Ideally, you should have a pretty big profit margin that exceeds your salary requirements. If you're a consultant earning $120,000 annually but would reasonably pay yourself $70,000 for similar work, that $50,000 difference becomes distributions exempt from self-employment tax, saving you roughly $7,650.

Learn more about S-Corp taxes and how you have to file them! 

You can also use this FREE S-Corp calculator to get a personalized answer on when an S-Corp is worth it for your business.

Why Would You Not Want to Be an S-Corp?

Still wondering, "Is S-Corp worth it?". Well, a few business situations make S-Corp election counterproductive or unnecessarily complicated:

• Low-profit businesses don't generate enough savings to justify the additional costs. If your business profits $40,000 annually and your reasonable salary would be $35,000, you're only saving self-employment tax on $5,000—roughly $765 in savings.

• Businesses with multiple owners face complications with the S-Corp election. All owners must receive reasonable compensation, and profit distributions must be allocated based on ownership percentages.

• Companies planning to reinvest all profits lose the primary benefit of the S-Corp election. If you're plowing every dollar back into equipment, inventory, or business expansion, you won't have distributions to save self-employment tax on.

• Businesses with irregular income struggle with mandatory payroll obligations. Seasonal businesses or project-based services that experience big income fluctuations may find consistent salary payments hard to maintain.

• Loss-making businesses provide no tax benefits through S-Corp election. You can't take distributions when there are no profits to distribute, and you still need to meet payroll obligations.

Most importantly, your profit margins can't be too thin to generate meaningful savings. Typically, this means your business should be making at least $60,000 and ideally over $100,000 per year.

FAQs

At What Income Level Is an S-Corp Worth It?

Generally speaking, you can start considering an S-Corp when your business generates $60,000-$80,000 in annual profit, though the exact threshold varies based on your industry and reasonable salary requirements.

For example, a graphic designer earning $75,000 might reasonably pay themselves $45,000, saving self-employment tax on $30,000 in distributions (roughly $4,590 in savings). After payroll costs, they'll still come out ahead.

But the higher your business income, the more you'll save. At $150,000 in profit with a $80,000 reasonable salary, you're saving self-employment tax on $70,000, which is over $10,000 in annual savings.

Does an S-Corp Really Save You on Taxes?

Yes, but only on self-employment taxes, not your personal income taxes. The savings come from avoiding self-employment tax on distributions. Instead of paying 15.3% self-employment tax on all profits, you only pay payroll taxes on your salary. The remaining profit distributed to you avoids self-employment tax liability.

What Is a Reasonable S-Corp Salary?

It depends on your industry. Your salary should reflect what you'd pay an unrelated person to perform your job duties in your geographic area and industry. Research salary data from sources like Glassdoor to see reasonable ranges for your role and location. In other words, you can't pay yourself $25,000 when similar professionals in your area earn $75,000. The IRS regularly audits S-Corp salaries that appear too low.

How Many Employees Can You Have with an S-Corp?

There's no limit on the number of employees you can hire. The employee count doesn't affect your S-Corp election status, and you can have as many employees as your business requires. However, adding employees does increase your payroll processing complexity and costs.

Should I Start My Business as an S-Corp?

No, most new businesses shouldn't begin with the S-Corp election. New businesses rarely generate enough profit in their first year to justify the additional complexity and costs. You're better off starting as a sole proprietorship or LLC, then electing S-Corp status once your profits reach the threshold where there are enough tax savings.

Find Clarity and Big Savings in Tax Season

At Desi Tax Service®, we help small business owners navigate complex tax decisions like whether or not they should elect the S-Corp status, and stay on top of their bookkeeping. If you are:

• Not sure if the S-Corp election makes sense for your situation

• Looking to understand what constitutes a "reasonable salary" in your industry and location

• Concerned about the additional payroll and administrative requirements of the S-Corp status

• Needing help calculating the tax savings versus additional costs for your business

• Overwhelmed by the ongoing compliance requirements and need systems in place

We can help you find clarity and keep more of your hard-earned money.

Schedule a consultation or learn more about our tax and bookkeeping services! Or, use this FREE S-Corp calculator to get a quick answer on whether or not an S-Corp makes sense for your business.