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My single-member LLC earned $180,000 in net income last year. Should I elect S-Corp status, and what are the self-employment tax implications?
For a Single-Member LLC (SMLLC) generating $180,000 in net income, electing S-Corp status is a classic tax planning strategy used to mitigate self-employment (SE) tax exposure. By default, an SMLLC is a "disregarded entity," meaning the entire $180,000 is treated as self-employment income subject to FICA taxes (Social Security and Medicare). By electing S-Corp status via Form 2553, you can bifurcate your income into a "reasonable salary" (subject to payroll tax) and "shareholder distributions" (not subject to payroll tax), potentially saving thousands of dollars annually.
S-Corp Election and Self-Employment Tax Dynamics
The transition from an SMLLC to an S-Corp changes how you are "paid" and how the IRS views your income. At $180,000 in net profit, you are significantly above the typical "break-even" point ($60,000–$80,000) where the tax savings outweigh the increased administrative costs.
1. Self-Employment Tax vs. Payroll Tax
- SMLLC Treatment: You pay 15.3% on the first 92.35% of your net earnings up to the Social Security wage base ($168,600 for 2024; $176,100 for 2025) [PDF] 2025 Publication 15-A - IRS. Above that cap, you continue to pay the 2.9% Medicare tax on all earnings, plus an additional 0.9% Medicare tax if your total income exceeds $200,000 (Single) or $250,000 (MFJ).
- S-Corp Treatment: You only pay the 15.3% FICA tax on the W-2 wages you pay yourself. The remaining profit is distributed as a "K-1 distribution," which is subject to income tax but exempt from both the Social Security and Medicare portions of payroll tax.
2. Comparison Table: SMLLC vs. S-Corp ($180,000 Net Income, 2024)
Note: Savings are reduced by corporate administrative costs (payroll services, Form 1120-S filing fees, and state entity taxes).
3. Section 199A (QBI Deduction) Impact
The S-Corp election has a complex interaction with the Qualified Business Income (QBI) deduction under Section 199A.
- SMLLC: The deduction is generally 20% of your net business income ($180,000).
- S-Corp: The deduction is 20% of your remaining profit after salary. If you take an $80,000 salary, your QBI base drops to $100,000 [PDF] 2025 Instructions for Form 8995.
- The Trade-off: While the S-Corp saves on payroll taxes, it may reduce your QBI deduction. However, at $180,000, the payroll tax savings almost always exceed the loss of the QBI deduction.
4. The "Reasonable Compensation" Requirement
The IRS requires S-Corp shareholder-employees to pay themselves "reasonable compensation" for services rendered before taking distributions S corporation compensation and medical insurance issues. If you set your salary too low to maximize tax savings, the IRS can reclassify your distributions as wages, triggering back taxes, penalties, and interest.
Audit and Practitioner Considerations
Determining the "right" salary is the most litigated area of S-Corp taxation. Practitioners should evaluate the following:
- IRS Challenge - Low Salary: The IRS frequently challenges S-Corps where the salary is significantly lower than industry standards for similar roles.
- Documentation Expectation: Maintain a "Reasonable Compensation Study." This should document comparable salaries using Bureau of Labor Statistics data or third-party salary surveys to justify the W-2 amount.3. Disqualification Facts: If the LLC fails to follow corporate formalities (e.g., co-mingling funds, failing to run formal payroll), the IRS may "pierce the corporate veil" or disregard the S-election for employment tax purposes.
- Health Insurance Trap: Health insurance premiums for >2% shareholders must be reported as wages on the shareholder's Form W-2 to be deductible by the S-Corp and excludable from the shareholder's AGI S corporation compensation and medical insurance issues.
Summary
- Net Income Threshold: At $180,000, an S-Corp election typically yields $10,000 to $13,000 in gross tax savings.
- Social Security Caps: The 2024 cap is $168,600; the 2025 cap is $176,100 [PDF] 2025 Publication 15-A - IRS.
- Strategy: Pay a reasonable salary (e.g., $75k–$90k depending on industry) to satisfy the IRS, while taking the remainder as distributions to avoid the 15.3% tax.
- Costs: Budget $2,000–$4,000 for payroll software, Form 1120-S preparation, and state-specific fees (like California's $800 minimum tax).
Suggested Next Steps
- Review Election Deadlines: For the 2025 tax year, Form 2553 is generally due by March 17, 2025. If you missed the 2024 deadline, you may qualify for "Late Election Relief" under Rev. Proc. 2013-30 if you have reasonable cause [PDF] Rev. Proc. 2013-30 - IRS.
- Perform a Salary Study: Use tools like Glassdoor, Payscale, or BLS.gov to determine a defensible salary for your specific role and geography.
- Implement Payroll: S-Corps must run formal payroll (withholding federal/state taxes, filing Form 941) to pay the owner's salary.
- State Compliance: Check if your state recognizes federal S-elections automatically (most do, but some like New Jersey or New York may require separate state-level filings).
References
Overview
Short answer: Electing S‑corporation status can reduce how much of your business profit is hit by ‘self‑employment tax’ (Social Security and Medicare). But you must pay yourself a reasonable salary through payroll and handle employer payroll taxes and filings. In California, an S‑corp pays a 1.5% state tax on its income and the $800 minimum franchise tax.
Below is what to do and how the rules work.
How your current single‑member LLC is taxed (no S‑corp election)
- By default, a single‑member LLC is ‘disregarded’ for federal tax. You’re taxed like a sole proprietor. Your net earnings from self‑employment are your business profit, and they are subject to self‑employment tax (Social Security and Medicare) under section 1402 (‘net earnings from self‑employment’) taxgpt.com/library1.
- IRS explains LLC classification: a single‑member LLC is a disregarded entity unless it elects corporate status www.irs.gov2.
What changes if you elect S‑corp status
- An S‑corp is a corporation that passes income through to you, but you are an employee for the work you perform. You must be paid ‘reasonable compensation’ as wages. Wages are subject to payroll taxes and withholding. The IRS says corporate officers are generally employees and should receive reasonable compensation; paying wages requires withholding and payroll tax compliance www.irs.gov3; www.irs.gov4.
- Any remaining profit after your reasonable salary passes through to you. That pass‑through is generally not subject to self‑employment tax (unlike sole proprietor profit), although you will pay income tax on it.
Payroll obligations (important)
- As an S‑corp employer, you must withhold federal income tax and the employee’s Social Security/Medicare from wages, pay the employer share, and file/submit employment tax returns (Forms 941/944 quarterly/annually and 940 for FUTA, and W‑2/W‑3 at year‑end) www.irs.gov5; www.irs.gov6.
California tax implications
- California S‑corps owe a 1.5% tax on California income and the $800 minimum franchise tax; they file Form 100S. California notes S‑corps must have separate bank accounts and records and are limited to eligible owners and 100 shareholders www.ftb.ca.gov7.
- An LLC must have the same classification for California as for federal. If you elect to be taxed as a corporation/S‑corp federally, California treats you the same for income/franchise tax purposes www.ftb.ca.gov8.
Self‑employment tax: comparing the two
- No S‑corp (sole proprietor): Your $180,000 net profit is generally ‘net earnings from self‑employment,’ so it’s subject to self‑employment tax under section 1402 (in addition to income tax) taxgpt.com/library1.
- S‑corp: You must pay yourself a reasonable wage. That wage is subject to payroll taxes. But profit left after your wage typically passes through without self‑employment tax. So, if your reasonable salary is less than your total profit, you often reduce Social Security/Medicare tax compared to sole proprietor treatment. The trade‑off is payroll administration and S‑corp compliance www.irs.gov3; www.irs.gov4.
How to elect S‑corp status (timing matters)
- File Form 2553 with the IRS. To be effective for the current tax year, file during the prior year, or within the first 2 months and 15 days of the year; all shareholders must consent. Late elections can sometimes be accepted for reasonable cause taxgpt.com/library9.
What you should do next
- Estimate a reasonable salary for your role. The IRS expects compensation commensurate with your duties; underpaying wages can trigger reclassification and payroll tax assessments www.irs.gov3.
- If the math works (salary + employer payroll taxes + California 1.5% tax + $800 minimum) still leaves you with savings versus self‑employment tax on $180,000, an S‑corp can be beneficial. Remember to factor in payroll service costs and extra filings.
- If you elect, set up payroll promptly and follow quarterly/annual employment tax deposit and filing schedules www.irs.gov5; www.irs.gov6.
- In California, plan for the S‑corp filing (Form 100S) and the $800 minimum franchise tax plus the 1.5% tax on income www.ftb.ca.gov7; www.ftb.ca.gov10.
Bottom line
- With $180,000 of profit, an S‑corp often lowers Social Security/Medicare taxes because only your W‑2 wage is subject to them, not the entire profit.
- Make sure you're comfortable running payroll and meeting S‑corp/California filing obligations. If you are, the election can be worthwhile. If you want, I can help you model a reasonable salary range and compare rough tax outcomes under each option using your California situation, so you can decide with numbers.
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