S corp election: when it saves tax and when it doesn't

Where the saving comes from

An LLC taxed under the default rules pays self-employment tax on the owner's whole share of profit. For 2026 that is 15.3% on net earnings up to the $184,500 Social Security wage base, and 2.9% above it, calculated on 92.35% of the profit.

With S status, the owner who works in the business is paid a salary through payroll. Payroll tax applies to that salary, at the same combined 15.3% split between employer and employee. The profit left after salary can be paid out as distributions, which carry no payroll tax. The saving is the payroll tax that would otherwise have been paid on those distributions.

Income tax does not disappear. The owner still pays income tax on the whole profit, salary and remainder together.

Example 1: $100,000 of profit

A single-owner LLC makes $100,000 of profit before paying the owner. These figures compare only self-employment and payroll tax, and leave out income tax, state taxes and costs.

At this level the saving can comfortably cover the extra costs, if $50,000 is a reasonable salary for the owner's role.

Example 2: $40,000 of profit

A saving of around $1,000 is easily used up by a payroll service, a separate corporate return and state costs. At this profit level the election often costs more than it saves.

The costs to set against the saving

• Payroll. Running payroll, depositing payroll taxes, filing quarterly Form 941 and year-end W-2s, and paying federal and state unemployment taxes on the salary.
• A separate return. The company files Form 1120-S every year and issues a Schedule K-1 to each owner.
• State taxes. Some states tax S corporations directly. California, for example, charges S corporations a 1.5% franchise tax on net income, with an $800 minimum.
• A lower QBI deduction. The qualified business income deduction is calculated on profit after the salary, so paying wages to yourself can reduce it.
• Less flexibility. Distributions must follow ownership percentages, and the ownership rules must be met at all times.

An S corporation can also make a state pass-through entity tax election. See PTET elections explained.

The reasonable salary rule

The saving depends on the salary being lower than the profit, but the salary must be reasonable for the work the owner does. The IRS looks at factors such as the owner's training and experience, duties and time spent, and what comparable businesses pay for similar services. An owner who takes little or no salary while drawing large distributions risks having the distributions reclassified as wages, with back payroll taxes, penalties and interest.

In the examples above, the salary figures are illustrations. The right salary depends on your role and your market. See reasonable salary for S corp owners.

Who can elect

• No more than 100 shareholders.
• Shareholders must generally be US citizens or resident individuals, or certain trusts and estates. Nonresident aliens, partnerships and corporations cannot be shareholders.
• Only one class of ownership. Differences in voting rights are allowed, differences in profit rights are not.

An LLC owned by a foreign person cannot elect S status. See how LLCs are taxed for the alternatives.

How to make the election

1. Check eligibility

   Confirm every owner qualifies and the operating agreement does not create a second class of ownership.

2. Complete Form 2553

   Every shareholder must sign the consent. An LLC does not need to file Form 8832 first.

3. File on time

   To take effect for a tax year, file no later than 2 months and 15 days after the year begins, or at any time in the year before. For a calendar-year business starting in 2027, that means by March 15, 2027.

4. Set up payroll before the first distribution

   Pay the owner's salary through payroll from the start of the S corporation year.

If you missed the deadline

The IRS grants relief for late S elections in some circumstances, generally where the business intended to be an S corporation from the requested date, has reasonable cause for the delay, and acts within the time limits set by the IRS procedure. The relief request is made on Form 2553 itself, with an explanation.

See late S corp election relief.

A rule of thumb

Look seriously at the election when profit after a reasonable salary is large and steady enough that the payroll tax saved clearly exceeds the added costs, including state taxes. For many service businesses that point is well above the profit of a first or second year. Run the numbers on your own figures before you file.

This guide is general information. It is not tax or legal advice for your situation.