LLC vs S-Corp Tax Comparison 2025

How LLCs Are Taxed by Default

A single-member LLC is taxed as a sole proprietorship by default. A multi-member LLC is taxed as a partnership by default. In both cases, the business income passes through to the owner's personal tax return, where it is subject to both income tax and self-employment (SE) tax.

Self-employment tax is the LLC owner's version of Social Security and Medicare taxes. In 2025, SE tax is 15.3% on the first $176,100 of net self-employment income, and 2.9% on income above that threshold (Medicare only, no cap). This rate is higher than what an employee pays because the LLC owner pays both the employee and employer portions.

Example: An LLC with $150,000 of net business profit. The entire $150,000 is subject to SE tax at 15.3%, which is $22,950 in SE tax alone, before federal and state income tax. Total effective tax rate (including income tax at 22% federal bracket) can exceed 35% on a meaningful portion of earnings.

How S-Corp Taxation Works

An S-Corp is not a different legal entity type, it is a tax election. An LLC can elect to be taxed as an S-Corp by filing Form 2553 with the IRS. From that point, the business is taxed as an S-Corp for federal purposes.

The key difference: in an S-Corp structure, the owner splits their income into two components. First, they pay themselves a "reasonable salary" as a W-2 employee of their own company. Second, any remaining profits are distributed as distributions, which are not subject to SE tax or payroll tax.

Example using the same $150,000 profit: the owner decides a reasonable salary for their role is $75,000. They pay payroll taxes (15.3%) on only the $75,000 salary: $11,475. The remaining $75,000 comes as a distribution with no payroll tax. Total payroll tax: $11,475 versus $22,950 in the LLC structure. Tax savings: $11,475.

The Reasonable Salary Requirement

The IRS requires S-Corp owner-employees to pay themselves a "reasonable salary" that reflects what the market would pay for their services. You cannot pay yourself $1 per year to maximise distributions and minimise payroll tax: this is specifically prohibited and is one of the most common S-Corp audit triggers.

Factors the IRS considers when evaluating reasonable salary:

• -What similar employees in similar businesses in your geographic area earn
• -Your qualifications and experience
• -The time and effort you spend in the business
• -The company's earnings history and dividend history

In practice, reasonable salary typically ranges from 40 to 60 percent of total S-Corp income for most service businesses. A freelance software developer earning $200,000 should probably pay themselves $80,000 to $100,000 as salary, with the remainder as distributions.

Pass-Through Taxation: Both Structures Qualify

Both LLCs and S-Corps are pass-through entities for income tax purposes. The business itself does not pay federal income tax. Profits and losses pass through to the owner's personal return. This distinguishes both structures from C-Corps, which pay corporate income tax at the entity level before dividends are distributed and taxed again on the shareholder's return (double taxation).

The Qualified Business Income (QBI) deduction (Section 199A) also applies to both LLCs and S-Corps. Eligible owners can deduct up to 20% of qualified business income, subject to income thresholds and limitations for specified service trades or businesses. This deduction is available for tax years through 2025 and is expected to be extended, but its status beyond 2025 depends on tax legislation.

Comparison: S-Corp Savings at Different Income Levels

Note: these figures are illustrative and use simplified assumptions. Actual savings depend on the specific reasonable salary chosen, state tax treatment, and S-Corp administration costs. Use the calculator on our homepage for your specific situation.

S-Corp Costs That Reduce Net Savings

The tax savings from an S-Corp election are real but must be weighed against additional costs:

• -Payroll processing costs: $50 to $150/month for a payroll service that handles W-2s, payroll tax deposits, and quarterly filings
• -Additional accounting fees: S-Corp tax preparation (Form 1120-S) typically costs $500 to $1,500 more per year than a simple LLC Schedule C
• -State franchise taxes: some states charge additional fees or franchise taxes for S-Corps (California's $800 minimum franchise tax applies)
• -Registered agent and state filing fees

Total additional costs of running an S-Corp versus a simple LLC typically range from $1,500 to $3,500 per year. This means the S-Corp election only makes sense once the tax savings exceed these costs, generally at net business income of $50,000 to $80,000 depending on your state and specific circumstances.