What exactly is an S Corp?

An S Corporation (S Corp) isn't actually a type of business entity—it's a tax election you make with the IRS.

When you form an LLC, the IRS automatically taxes you as a Sole Proprietorship (if you're the only owner) or a Partnership (if there are multiple owners). This means all of your business profit passes through to your personal tax return, where it's subject to both income tax AND self-employment tax (15.3% for Social Security and Medicare).

The Self-Employment Tax Trap

As your business grows, that 15.3% self-employment tax becomes a massive burden. If you net $100,000, you're paying over $14,000 in self-employment taxes alone, before you even calculate your regular income tax.

How the S Corp Election Solves This

When you elect to be taxed as an S Corp, you change how the IRS views your income. Instead of all your profit being subject to self-employment tax, you divide your profit into two buckets:

• Bucket 1: Your W-2 Salary. As an S Corp owner, you must pay yourself a "reasonable salary" through payroll. This salary is subject to the 15.3% payroll taxes (the equivalent of self-employment tax).
• Bucket 2: Owner Distributions. The remaining profit after your salary is taken as a distribution. This money still passes through to your personal tax return for regular income tax, but it is completely free from the 15.3% self-employment tax.

When should you elect S Corp status?

Generally, the S Corp election starts making sense when your business is netting $80,000 to $100,000 per year. Below that threshold, the administrative costs of running an S Corp (payroll processing fees, separate corporate tax return filing fees) often outweigh the tax savings.